Melbourne, 24 December 2010

ANZ analysts have just returned from a 2 week trip to China and the feedback was generally positive. Most saw the recent slowdown as temporary, or off a high base, from the winding down of strong stimulus demand – and government cooling from bank lending and power restrictions. The outlook for domestic commodity demand looked positive in 2011. A major theme was strong demand and construction of low-income affordable housing. Power restrictions will also pass, returning most heavy industry users to higher capacity levels.

"There were concerns over rising inflation, with most expecting the government to raise interest rates in 2011. This was likely to curb some of the more ambitious capital-intensive construction projects. It would also inhibit stronger stockpiling, with most inventories financed on cheap domestic credit. The currency was expected to appreciate, albeit slowly. Feedback was that authorities were wary of repeating the sharp slowdown in Japanese growth in the 1990s after a rapid appreciation of the Yen in the 1980s.

"Discussions over the new 5-year plan (starting in 2011) revolved around the rebalancing of growth and incomes between urban and rural regions. A move towards developing better infrastructure in the inner western provinces was seen as a positive commodity demand story, requiring long distance transport infrastructure and a substantial lift in urban development. An interesting angle was an accompanying rise in western China exploration activity – a lot of the region is untapped and is potentially holding large quantities of commodity resources.

"The inventory picture looks mixed. Government cooling and cheap credit had seen a build in most producer stockpiles – particularly in steel and base metals. Bonded copper stockpiles have apparently doubled since we last visited in August from about 150kt to around 300kt (unconfirmed). Steel stocks were high, but a recent pick-up in high-end steel product exports was creating a mild drawdown in inventories. Downstream manufacturing inventories were a lot tighter, with most operating on a just-in-time basis. The Ags story looks tight. One contact suggested domestic cotton stockpiles had been completely exhausted.

"Current housing market conditions were pretty strong. The copper tube market was quite buoyant (used predominately in apartment air conditioning). The feedback was for even better conditions in 2011. The new 5-year plan would usher in a big rise in affordable housing to address the widening affordability gap for most urbanising Chinese. The growth targets looked very impressive, with the government planning the commissioning of 10.5 million new apartments in 2011 – well above the average 6 million units built annually over the past 10 years.

"From a commodity point of view, the gold and iron ore markets appear to be holding strong appeal. Concerns about higher-than-stated domestic inflation conditions were spurring strong interest in gold (as a hedge). The strong housing market story in 2011 and the view that domestic iron ore output growth would slow was fuelling a positive outlook for rising iron ore imports. A lot of interest was expressed in investing in offshore commodity supply, with particular focus on iron ore, both coals and nickel.

Ends --

Mark Pervan, Head of Commodity Research, ANZ Bank.

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