Monthly Archives: February 2013
Long positions powered by optimism are pushing the LME higher. However, risks still exist in the global economic system. Some of these risks include the US fiscal situation, the European structural malaise, the Chinese structural dilemma and the potential shocks that may arise from unlimited money creation. The price outlook for 2013 remains flat to marginally positive. Production ex-China may remain negative for another 5-6 months, and we will see the cuts to reduce. This is reflective of the return of final demand. Further data points from the demand side are needed to confirm a recovery scenario. It may very well be that the market is currently driven by an irrational sense of optimism as there is a tendency to overestimate price gains before recovery.
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Is it a good time to buy aluminium?
In a recent China Daily article, it was mentioned that China’s aluminum stockpiles have reached a new high. However, the Chinese demand situation is less certain than a scenario produced in a simple linear extrapolator. Key markets such as construction and machinery equipments are constrained by structural factors. Adjustments on property prices and advanced countries deleveraging mean construction and export market demand are suppressed.
Other demand such as in automobiles and even in consumer goods has been more flat than desired.
Additional capacities will come online in 2013, and this will put downward pressure on metal price, which will continue to deteriorate the smelters’financial positions. This fits the broad conceptual description of China’s structural dilemma: over-capacity in the aluminium industry + slow-recovering demand = a deflated metal price.
The possibility of a major destocking rose in the beginning of 2013; however, price continued to deteriorate while stocks fell for a few weeks.
The holiday season distorted the inventory data and a sudden jump in inventory levels occurred immediately after, which is no big surprise as the level of stock increase is similar to that of last year’s level. Yet while the trend of destocking has been broken, it is rather hard to make a call on the data.
Invisible inventory is the hidden side of the inventory story. While there is no official account for the data, one can safely assume that it is expanding at the same rate as visible inventory. Therefore, it is still a good indicator of demand; and historical data does suggest a significant statistical relationship between the two.
How about the SRB? This is really about fiscal policy, isn’t it. After attending numerous macroeconomic and policy conferences, we get the feeling that fiscal policy will be tempered this time round. Secondary industry players are struggling and are hoping for some sort of fiscal relief. The mentality of moral hazard is deeply seeded in the working of China’s economic machine. However, China is facing a crisis, a structural dilemma if you will, and there is less incentive to pop up fixed investment again.
Is it a good time to buy aluminium? The China Daily article suggests yes.
However, buying decisions are not solely made based on the price of input commodities, except for possibly traders. The two major questions are: is there enough end demand to justify buying? Is the buyers’ revenue outlook and total cost metric going to justify input commodity purchases? For a builder or car manufacturer, if the outlook for construction or automobile remains dim, then the purchase of metals would have to be carefully matched to future demand levels. It is hard to justify the stocking up of input commodities when future demand is going to be poor; and very possibly, the down-stream buyer may have inventory problems with its own production, this would discourage inventory building further, even if is cheap.
Excerpted from our monthly India report, email enquiries@az-china.com for subscription details.
Indian Oil Corporation (IOC) conducted GPC e-auctions on 29 January 2013, and the results of which for three refineries are tabulated below. 
Abbreviations used: ICL – India Carbon Group; MGI – Maniyar Group of Industries; GIL – Graphite India Limited; PI – Premier Industries; KH – Krishna Hydrocarbons
Rio Tinto and its subsidiary Pacific Aluminium have announced they will keep the Gove refinery operating.
This follows the Northern Territory Government’s decision to release gas from its supply contract with the major gas supplier in the area.
The deal still requires a few more pieces to be put into place. Someone has to build the pipeline from the gas field to the Gove refinery. This is estimated to cost around $500 million, so will require at least some level of involvement from the Federal Government in Australia. The gas company will have to spend another $500 million to increase their capability at the gas field. And the refinery will need an estimated $200 million to convert the plant to natural gas.
On top of all these direct costs, the people of the Northern Territory are now exposed to the gas market sooner. The NT government effectively handed its gas rights to Gove, at an estimated cost of $1.2 billion. The government had a 25 year contract at a price well below market, but the quantity in the contract didn’t include Gove.
So a couple more steps are still needed. And Gove will have to continue limping along at break-even or worse until the gas becomes available in 2015 or thereabouts.
And when you look at this announcement, it does beg a couple of niggling questions. It’s a great piece of news for the local workers, and it helps sustain the value of the downstream assets in PacAl, but almost nobody else wins. The NT Government will lose $1.2 billion, by its own admission. The gas company will outlay $500 million, though it will recover this with interest in its prices. Gove will outlay $200 million plus operating losses through until the gas gets connected. On top of that, there is an opportunity cost to RT - one newspaper estimated that it will cost $500 million per year in lost profits by not simply selling the red dirt as is. Which is precisely what RT does with most other products it sells.
Is this announcement simply a way to transfer blame to someone else, in the expectation that the deal will still fall through? Is RT betting that the Federal Government won’t be able to underwrite the pipeline, or that some other piece of the puzzle falls out?
The incumbent Federal Government last year agreed to pay $40 million over 2 years to save the Point Henry smelter (which does not get alumina from Gove). So it is already supporting the aluminium industry. But this would involve an investment 10 times larger, and with fewer jobs at risk (and therefore voters). Perhaps RT is betting on the likelihood that the present government will likely lose the upcoming election. That would bring in a conservative government, who would be less open to government intervention in private industry.
I hope I am wrong, for the sake of the people who depend on the refinery for employment.
The Northern Territory Government has announced that it can and will supply enough natural gas to the Gove alumina refinery for the next 10 years. The supply is subject to Rio Tinto agreeing to keep the plant running.
Rio had said that the plant’s future hinged on supply of natural gas. The refinery presently operates on fuel oil, which has become prohibitively expensive and pushed Gove’s operating costs to $400/t.
But although the NT government has come up with the gas, someone else has to pay to get the gas to the plant, then to hook up the gas to the kilns, replace the burners and adjust the fume exhaust system and so on.
The NT government may have agreed to get into the marriage bed with Rio, but it will be the Australian Government who will be expected to provide the dowry. And with a bill in the billions, there’s no guarantee that the Federal government will cough up. Although it’s an election year in Australia this year, there’s not many votes in that far-flung corner of the country, and the Government isn’t exactly swimming in cash.
We hope for the sake of the locals that this marriage proceeds, but there’s still some way to go yet.
As hundreds of millions of Chinese have returned to their homes this week, to celebrate Chinese New Year with their families, it is perhaps a good time to reflect on the longer-term situation here. After about 30 years of the one-child policy, China is rapidly entering the 4-2-1 crisis, where one young Chinese worker could find themselves having to care for 2 parents and 4 grandparents. But many young Chinese workers do not have the income to support even themselves.
Meantime, China’s elderly look at the Chinese economy now, compared to when they were growing up, and wonder what is happening to the country they love. Just one generation ago, millions of Chinese starved, as Chairman Mao pushed ahead with his Great Leap Forward. Those that survived that awful time are now in their 60s, 70s or 80s, and see the rate of growth and the enormous wealth that some have garnered, yet find themselves barely able to eke out a living.
So China is in great danger of getting too old before it gets rich. But getting rich before getting old is also not necessarily a good thing. Countries such as the USA and Japan have been wealthy for some time, but the generations that own the wealth are now moving into their retirement years, while younger workers struggle to find a job with the benefits that the previous generations enjoyed.
This is a long explanation and introduction to a piece written for the East Asia Forum by a friend of mine. Lauren Johnston, an Australian who has just completed her PhD here at Beijing University (in Chinese), writes that the Chinese Government is taking actions as swiftly as it can, yet the challenges it faces are daunting. Simply caring for the aged is a problem in China. The average monthly wage of a nurse in China in constant 2005 dollars is approximately US$187, while in Japan that wage is more than 10 times higher, at US$2140.
Lauren wrote two versions of this piece, one for the East Asia Forum, that you can see here, and the other for Sinograduate, a website devoted to assisting foreign students to study at post-grad level in China. You can see that version here.
新年快乐, or if you like, xin nian kuai le, means happy new year in Chinese.
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All of us here at AZ China wish you a happy new year of the snake. (Don’t worry - the snake is a good sign in Chinese astrology.)
Forward the tax piece on Beijing’s chessboard
Beijing unveiled new guidelines on tax reform on Tuesday the 5th of January 2013. The plan will target SOEs, property speculators and the rich; the plan also aims to narrow the gap between urban elites and the poorer rural population. We shall analyze how these steps will restructure and balance China (in part two of ‘Balancing China’). But firstly, let’s take a bottom-up approach to understand the imbalance; it will shed light on what needs to be done.
The post-graduate returnee
A returnee from a 2-year post-graduate program in the UK arrives back in China and contemplates the future. He or she decides to go to one of the major cities in China where higher living standards, service sector job opportunities and the promises of growth await. This city happens to be Beijing or Shanghai. He or she finds a job with a company at a starting salary of 3,000RMB per month (average monthly salary is somewhat higher than this), equivalent to 476USD per month. He/she has no local ‘Hukou’ meaning that he or she cannot enjoy social security and medical benefits at the level a local would enjoy. While staying at a poorly renovated shared accommodation in the city, he or she pays more than half of the salary on rent. Little is left for buying new clothes and eating out at fancy restaurants. He or she is around 25-26 years old. After much soul searching, he or she questions why the skyscraper and BMW promises are not coming true.
He or she then contemplates the need to purchase residential housing. After using the mortgage calculator on one of the major commercial bank’s website, he or she concludes that a 50-60sqm apartment would require a substantial down payment of up to 600,000RMB, this will take more than 150 years to save up on his or her current salary, provided that all income go to saving. His total loan repayment, containing interest, is at around 1.6M RMB; this is provided that the down payment is available. The entire calculation requires a monthly repayment of around 10,000-13,000RMB, which is 4 times his or her current salary. After accepting the reality that he or she will never be truly independent from the family, he or she concludes that the down payment would be produced by savings from his or her parents, which may be raised by the sale of assets or properties in his or her hometown. The repayment will need to be made by two people, implying he or she needs to get married. Each side would pay at around 5000RMB or more per month, meaning their monthly salary need to increase. This is of course not taking into account future inflation growth, and the fact that wage growth which he or she solely needs would feed back into inflation growth. Unfortunately, the cost of residential property grows as the family size increases, as the size of the apartment grows to roughly 90sqm. Total repayment, interest payment, monthly payment and down payment all increase substantially, and would have to stretch out to around 30 years.
On his or her way back from the bank, the pollution is at dangerously high levels of pollution and he or she is now worried about his or her future children, on both health concerns and education. His or her own retirement scheme will make small monthly payments to his or her account upon retirement, now concerns about retirement enters the mind. Medical expense is another unthinkable cost to this already over-burdened youngster.
Looking down from above
Let’s try to answer some of our returnee’s questions. Why are there so many skyscrapers and BMWs when he or she struggles to survive? There is no doubt that most of this growth is genuine, but the point is a rather deeper one. The current economic model has been moving wealth from the consumers or the demand side and pumping them into investments. As a result, investments in properties and factories grew rapidly to the point of oversupply. Also, owners of investments have benefited from this transfer of value or wealth.
Why is there little consumption in China relative to investment? Inflation in substantial amounts of assets has been driven up by capital and by citizens with capital. This is evident in the property market. Purchasing power is eroded by inflation in hard assets and undermined by poor social securities and costly medical services.
What is happening to savings? China has a high saving rate; however, this is not the same as having a high amount of saving relative to asset prices. Due to high prices in areas such as housing, people born in the 80s and 90s are facing a situation where their income cannot support the purchase of residential housing and even automobiles. Naturally, people turn to borrowing through either the banking system or equities from their families. The people who cannot finance through family savings are left to rent or live with their family; the people who can finance through family savings would do so. This is basically direct equity investment mixed with banking system credits; it concentrates price inflation in certain assets, adding to risks of bubbles. At the same time, it still erodes consumption because debts and repayment of interests remain expensive.
The fact of the matter is this recycling of savings from the older generation will continue into future generations. Depending on the rate of inflation relative to savings, future generations have the potential to become poorer. For example if savings are stored in inflation protected assets such as land or properties, future generations will not become poorer. If their wealth is stored in cash, there is risk of wealth erosion which makes this recycling of savings unsustainable.
One would wonder whether income growth is the answer. That depends on if it is nominal income or real income. If nominal income grows, purchasing power can improve in the immediate short term, however, it feeds back into inflation, eventually leaving no change in real wage. So the problem is really price and inflation. There are several price ranges for goods and services in China, each capitalizing on a specific category of income earner. This price discrimination mechanism actually helps to make goods and services affordable for citizens. However, the quality of living differs dramatically across different income groups. The biggest challenge remains in hard asset prices, such as in land and properties. Improvements will likely come from gradual increases in real wage against property prices, or the success of government social housing programs, aiming at increasing housing supply and lowering price.
To be continued…
Next I will have a look at China’s proposed tax reform.
A series of articles in today’s Fairfax newspapers in Australia gave coal barons, shipping magnates and slide-rule wielding analysts a minor case of heart burn.
According to the articles, China is set to cap coal consumption at 4 billion tonnes. Authorities such as the NDRC and the China Academy of Social Sciences were quoted, and the articles mentioned that China’s State Council had approved the energy plan.
Journalists soon flocked to the coal companies and other affected groups seeking comment, in the expectation that such a cap could cause China to cease buying coal.
The problem is, the journalists failed to do their job properly. If they had looked closer, they would have seen that the target was expressed in “Tonnes of Coal Equivalent” - TCE. That’s an energy measure that China uses instead of “Tonnes of Oil Equivalent” - TOE - which most other countries use.
But isn’t a tonne of coal “equivalent” to a TCE? No, not when you are measuring Chinese coal. Most Chinese coal is not up at the optimum 7000KJ, and is instead around 5000-6000KJ. That means that 1 tonne of TCE is equivalent to about 1.5 tonnes of Chinese coal. So, for China to cap consumption at 4 billion tonnes on a TCE basis, actually that allows another 50% growth on where they are at today.
And let’s face it, China cannot survive without coal in the short to medium term. It is not possible to build sufficient energy capacity in wind, solar and other renewable energy sources. Nuclear power stations take 10 years to build. And China needs energy to fuel the ongoing growth of its economy.
Anyone who had any illusions about China being a country ruled by a political party, not a government, only needs to look at what has been happening here the last couple of months.
China has been dealing with a number of issues, internally and externally. Within China, corruption has been the watchword, while more recently the focus has also shifted to fighting pollution, after Beijing choked on some of the worst readings in the city’s history. Economic issues have also been a central focus. Externally, squabbles with a number of countries have been escalating, especially the ongoing dispute over the Senkaku/Diaoyu islands.
And who has been at the helm? Who has taken the lead on most of these issues? Xi Jinping has been at the forefront on many of these challenges, most recently chairing a committee to deal with the rising tensions with Japan. Yet Xi Jinping is not yet the President of the country. Li Keqiang is not yet the Premier, yet he chaired a meeting to decide on economic policy and direction recently. The new leadership does not get installed for another 5 - 6 weeks.
Yesterday for possibly the first time since November, Premier Wen Jiabao was seen in public, chairing a session of the State Council. It was in November that the Communist Party chose a new Secretary-General in Xi Jinping, and a new Politburo. It has been these people who have led China, using their positions of authority in a political party as a proxy for authority in government.
In China, government is an administrative arm and sometimes nothing more than a front for the Party. Be under no illusions - this is a Communist Party country.
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