London, January 2011

China's imports of industrial metals fell across the board last year relative to 2009. Those of iron ore and refined copper held up the best, registering declines of 1 percent and 8 percent respectively. At the other end of the scale imports of refined lead and primary aluminium each slumped by around 85 percent.

It's a counter-intuitive outcome, given the strength of Chinese manufacturing output, which carried on booming last year in marked contrast to "old world" economies, where factories were hauling themselves back to pre-crisis levels of activity with varying degrees of success. Actually, it's also a statistical quirk, saying more about imports in 2009 than in 2010. Easy to forget now but China too was caught up in the Great Contraction of early 2009 with export orders falling off a cliff and smelters adding to ever-growing mountains of unsold metal.

The Chinese government intervened in the worst-affected sectors. The State Reserves Bureau (SRB) bought up aluminium and zinc at above-market rates to stabilise local prices and regional governments offered a helping hand to those metals producers most important to the local economy.

The result in several metal markets was the opening of an arbitrage window with LME prices, through which large amounts of metal flowed as opportunists capitalised on the flood of government loans to turn a quick profit. The exception was copper, where the sudden drop in prices allowed China Copper Inc., not least the SRB itself, to replenish drastically depleted stocks.

A more telling perspective on last year's imports comes from a comparison with 2008. Relative to that year imports of all the base metals and of iron ore grew sizeably in 2010, with one single exception.

Graphic on China's 2010 imports relative to 2009 and 2008

THE PROBLEM WITH LEAD (AND ZINC)

Lead was the stand-out in the general trend. Imports of refined lead last year fell by 86 percent relative to 2009 and by 30 percent relative to 2008. On a net trade basis China wasn't an importer of refined lead at all last year. It was a net exporter, albeit to the marginal tune of 1,538 tonnes, and that despite a sizeable 10 percent duty on exports of refined metal.

This might seem surprising given the fact that China is the world's fastest-growing consumer of the heavy metal thanks to its ascendancy in global auto production and the proliferation of the lead-battery-dependent e-bike. However, the country's production has also been growing at a fast clip. Last year was the third consecutive year of double-digit growth in refined production. And that's just according to the official figures, which do not fully capture either the "grey" micro smelter sector or the country's booming secondary lead sector.

How come then, you might reasonably ask, is China still a consistent importer of lead's sister metal, zinc ? Net imports of refined zinc (not including alloy) were 280,000 tonnes last year, down from 640,000 tonnes in 2009 but still higher than 2008's 112,000 tonnes. After all, China's production of refined zinc grew by almost 20 percent last year, even faster than that of lead. And 326,000 tonnes of metal sitting in Shanghai Futures Exchange ( SHFE) warehouses, a life-of-contract high, suggest that the local market is saturated.

Even China bulls such as Barclays Capital concede that China has no physical requirement for all that zinc flowing into the country every month. Rather, it is the very fact that the metal is traded on the SHFE that allows opportunists to play the financial arbitrage between Shanghai and London. Nor is there any reason to expect any different in 2011, at least while the SHFE zinc contract remains the day-trader's choice in China. And if you're looking for China to turn net importer of refined lead in a big way this year, the SHFE's stated ambition to launch a lead contract will probably be as important as any fundamental drivers.

A BUYER AT ANY PRICE?

Two metals that China really does need are copper and tin to the extent that the Dragon's appetite for imports is hardwired into each metal's bull narrative. Chinese net refined copper imports fell by just over 7 percent last year relative to 2009 but that year marked a stepchange in historical trade patterns. Imports were still double the figure in 2008, a more illuminating comparison.

Bulls are expecting more of the same this year. Chinese buyers have been conspicuous by their absence from the spot market for several months and local physical premiums have tumbled. That, however has only stoked expectations that China Copper Inc. will restock heavily after the start of the Chinese New Year in February.

Graphic on China's refined copper trade 2007-2010

The only problem is that history and "normal" consumer price behaviour suggest otherwise. Prices are at record highs and the last time this happened, back in late 2007 and early 2008, the Chinese just carried on de-stocking and imports remained extremely low.

Back then the market was as equally convinced as it is now that the great restock was just around the corner. It didn't happen until the price collapse in late 2008 but by then the copper bulls had other things to worry about.  De-stocking is by definition a finite phenomenon but it is quite possible that we're in for another prolonged staring match between China Copper Inc. and a bullish Western market.

It's noticeable that Chinese imports of tin have tailed off dramatically since that metal started hitting record highs back in October. Net imports in Q4 2010 were 2,218 tonnes, the lowest three-monthly total since mid-2007 when the country was still oscillating between net importer and net exporter.

Graphic on China's net refined tin imports 2007-2010

The point being that super-high prices generate a natural buyer aversion to purchasing anything other than "musthave" metal. In the case of copper there may be one important exception. The SRB is to separate out its commercial and its strategic operations, meaning the latter could carry on buying commodities at any price, if it is deemed to be in the national interest to do so.

Such a separation of functions is most likely aimed at the agricultural sector, reflecting Beijing's over-arching concern about food price inflation. But could it also mean that the SRB will continue to restock copper even at record high prices? If it does, it will be the single most important factor in the scale of this year's imports of refined metal.

PRODUCTION DRIVERS

In the case of nickel and aluminium the most important driver of this year's imports will be China's own production. Surging nickel pig iron (NPI) production has lessened the country's need for imported refined metal.

Although 2010 imports of nickel at 183,000 tonnes were up 55 percent on 2008 levels, there was also a marked jump in exports. Net imports of 128,000 tonnes were up by only 14.5 percent on 2008.

Graphic on China's net refined nickel imports 2008-2010

Graphic on China's imports of ore from Indonesia and the Philippines

Part of that modest rise may be due to de-stocking after last year's bumper imports but most analysts also point to the super-fast growth in NPI, a cheaper and therefore preferred nickel input for many stainless mills.

However, those NPI producers using blast-furnace technology are notoriously cost-sensitive and the cost of one of their key raw materials, coking coal, has just rocketed in price after the Queensland floods.

Imports of nickel ore, the other key NPI input, showed no signs of slowing in the closing months of 2010 but the nature of the coal market, based on quarterly pricing, means the full price impact may only be felt in the coming months. A reduction in NPI output should in theory at least translate into stronger refined metal imports.

China's aluminium production, meanwhile slumped by an annualised 2.65 million tonnes between July and December last year, reflecting Beijing's drive to hit energy efficiency targets before the end of the old five-year plan in December.

All things being equal, China's opportunistic smelters might have been expected to reactivate that capacity just as soon as Beijing turned its attention elsewhere. However, severe winter weather conditions in many parts of the country have hit power generation and delayed planned restarts.

The result has been a big drawdown in inventory, estimated by researchers at Macquarie Bank to be in the order of around 870,000 tonnes. So far this has largely affected off-market rather than SHFE stocks but as long as production remains so constrained, it may only be a matter of time before the latter start being tapped. If that happens, local prices will react, opening up an arbitrage window with the LME and stimulating imports.

China's net trade in refined aluminium was pretty finely balanced last year and net imports were a lowly 36,000 tonnes. Even that figure is slightly misleading because the country extended a trend of growing net exports of both alloy and products to the tune of 426,000 tonnes and 1.6 million tonnes respectively.

Graphic on China's trade in unwrought aluminium

Graphic on China's exports of aluminium products

Aluminium bulls have been predicting a shift to net importer for many years now and there have been many false dawns. But the scale of the recent production cutbacks has been huge and unless they start to be rolled back soon, China could see another big step-change in its net primary metal trade.

Ends --

Andy Home, Reuters Columnist - for Commodities Now with permission.

The opinions expressed are his own.