“China is running out of big things to build”

Via Tom Price, head of commodities at Macquarie:

The world’s metal producers, traders and market commentators arrive in London this week for a big annual gathering. We expect the debate to focus on how to position for a full US-China trade deal, or expanded fiscal stimulus in China.

But this is all just short-term noise.

Investors should be considering the longer-term growth risks to commodities from changes in the world’s second-largest economy. Any evidence of a slowing rate of consumption in China is critical to the outlook for global commodity prices. Investors in metals and rocks need new strategies to better handle this transition.

Simply put, China is running out of big things to build. Key commodity-consuming sectors such as property and infrastructure — which have seen massive-scale construction activity over several decades, from a very low base — are now in a mature stage of development. China’s new-build period is giving way to the less commodity-intense phase of replacement.

Current global commodities consumption is, we estimate, no more than 60 per cent of what it was during the China-backed growth surge of the early 2000s, and no more than 80 per cent of its level during the modest global economic recovery in the early part of this decade.

In fact, the current consumption rate resembles that of the 1990s — a decade featuring the US and Japan as the big commodity consumers, long before China’s massive-scale growth cycle occurred.

Here are three strategies that investors could use to trade this longer-term trend.

First, choose base metals over steel. History shows that when major economies (particularly Japan, Germany and the US) peaked in terms of their commodity consumption, steel usage enters a multiyear trend decline, while that of base metals holds up.

This is because there is little to replace the steel demand for massive-scale national infrastructure investment. Base metals, on the other hand, see declining industrial demand offset by growth in short lifecycle consumer goods such as cars, machinery and appliances. Recommended Tail Risk Neil Hume Industrial metals offer insights into world economy

Second, take advantage of growing complexity in China’s industry. As longstanding growth in the country’s materials-intensive industrial and manufacturing sectors naturally slows, it will be incrementally replaced by domestic consumption and trade.

This will mean a decline in the intensity of steel use and the rise of demand for more complex commodities such as mineral sands and pigments used in paint, plastics and paper; ferroalloys added to steel; and inputs for chemicals production.

Third, buy what China lacks. While its growth rate for total commodities may moderate over the longer term, there are selected commodities whose total supply in China are largely met by imports. For example, more than 50 per cent of China’s supply of iron ore, copper, nickel and bauxite are imported — making these commodities less sensitive to domestic economic drivers such as currency weakness and trade conflict. By the same token, avoid those commodities in which the country is naturally “long”: aluminium, coal and steel.

Yep. Recall that it was in 2011, eight long years ago, that China itself said it no longer had anything profitable left to build. Since then, the output of building per annum has almost doubled:

Scrap inputs are up from 15% to 20% over the same period:

And the future is bleak for iron ore (and weak for coking coal):

We agree with Macquarie that the turning point is more or less here, held off only by a serendipitous Vale accident.

Iron ore is a major sell into the 2020s.

David Llewellyn-Smith
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