China copper inventories swell to over 1 million tons

Chinese copper inventories held up in the bonded warehouses may have passed the 1 million ton mark and along with inventories, there may be as much as 1.4 million tons of copper sloshing around China.

“The problem is that inventories remain high, equivalent to three months’ imports at current rates at more than 1 million tonnes. And that’s just stockpiles in bonded warehouses, which don’t include other inventories, meaning the total may be closer to 1.4 million tonnes, representing a substantial overhang,” writes Clyde Russell from Reuters.

China’s copper imports rose 13.5% in November from the previous month, but that is only a partial reverse from a 18.5% drop reported in OCtober..

Last week, speculators increased their bullish bets on copper by 15,034 contracts, for a net long of 13,841 contracts from a small net short of 1,553 lots in the previous week.

Floating yuan gets China less gain, Fed

China would do better if it liberalized its capital account while simultaneously allowed its currency to float although gains from liberalizing its capital account outweigh free-floating currency gains says San Francisco’s Fed paper.

“The last option, that is, combining an open capital account with a floating exchange rate, best weathers a foreign interest rate shock. Most of the benefits stem from liberalizing the capital account. With an open capital account, the central bank does not need to sterilize purchases of foreign capital inflows,” say the authors of the Fed’s Economic Letter.

China currently imposes capital controls on its people, meaning Chinese who make foreign currency by exporting things have to surrender that currency to the central bank (PBOC) and the, in turn, stores this foreign currency cash in things like US Treasuries.

When many Chinese exporters surrender their dollars to PBOC they get yuan so in order to offset this increase in the money supply of yuan, PBOC issues domestic bonds at a specified interest rate in order to mop-up that newly printed cash. This process is called sterilization.

However, since 2008 when US rates have dropped to near zero, China has been whining about it because the US paper that they are holding is earning them less interest while the rate they have to pay on sterilization has gone up to offset inflation (see chart above).

“Thus, the 2011 current account surplus, equaling a net inflow of $360 billion, translated into an estimated net PBOC loss of over $10 billion,” says the Fed.

As sterilization costs increased, PBOC did less of it and instead let the money supply increase.

“Expanding the money supply boosts real economic activity in the short run. But it also causes inflation to tick up. That is what China experienced in the years immediately following the global financial crisis,” says the Fed.

Hence we see bubbles in things like houses.

To eliminate the sterilization costs, Fed says China can either (1) keep its yuan pegged but free up capital account or (2) float the yuan and keep capital controls.

First option would kill the inflation but would tank the GDP and drop the yuan more. Second option makes yuan more expensive at the cost of exports.

“Overall, these results suggest that China would benefit more from liberalizing its capital account than from letting its exchange rate float… additional stability that comes from also allowing the exchange rate to float appears modest.”

China PMI has stopped falling

Survey of private factory managers by the HSBC Purchasing Managers’ Survey rose to 50.5 in November fro the shrinking 49.5 in OCtober.

The official PMI survey of China’s non-manufacturing sectors also ticked up, to 55.6 in November from 55.5 in October.

For some, these readings definitively confirm that China has bottomed and going forward, with the new political regime in power now, expansionary policies will crank up growth.

The problem that others see, besides claims that these numbers are cooked-up, is that much of this PMI growth is based on state-investment.

“The improving numbers [in PMI] are mostly  because of government investment. From the second quarter the government has unleashed a lot of projects, and that has started to be felt in the economy, but it’s not a very healthy recovery yet,” said Dong Xian’an, economist with Peking First Advisory.

Others think that state-led investment is the old trick which may not work to achieve the proclaimed reform goal of a consumption-led economy.

“Whilst we feel that the economy has been stabilized through the short-term, we feel that the manner in which activity has been revived will retard China’s economic reform agenda and make the transition onto a sustainable footing all the more tricky,” wrote Xianfang Ren and Alistair Thornton of IHS Global Insight.

At issue, in the long-term is the effectiveness of this new, higher investment, a problem eastern European countries experience during communism – an ever increasing investment yields a decreasing GDP growth.

“Production can continue (hence contributing to GDP), and employment can remain tight. Our fear, therefore, is that whilst activity is resuming, economic efficiency is declining. This has negative longer-term consequences,” IHS says.

China clocks PMI growth

The HSBC flash China manufacturing purchasing managers index (PMI) clocked at 50.4 in November versus 49.5 in October.

China’s manufacturing output index also rose to 51.3 from 48.2 points previously.

Anything above 50 is growth so this reading of the HSBC’s index sets the stage for a more robust official PMI release later.

HSBC PMI is weighted more towards smaller enterprises versus the official Chinese PMI which favors large state firms.

As a result, the government PMI is often a much stronger number so in this case the official Chinese PMI, which comes out one week after HSBC, will most likely show a much more robust growth.

This reading should give a boost to the commodities and the Australian dollar.

“If the Aussie dollar does indeed trend higher in line with higher demand and prices of raw materials, then there is no issue, that’s what the currency is expected to do. But if the Aussie rises further and faster than commodity prices then it represents a tightening of policy settings. So it seems another coin toss whether the Reserve Bank cuts rates in December or holds off until the new year,” says Commonwealth Securities chief economist Craig James said.

Chinese metals stockpiling to have little effect, analysts

Chinese government is expected to soon start a stockpiling program of buying excess metal such as copper (see story here) but analysts are saying that such program will have little if any effect on prices.

“On copper, it is difficult to see the move lifting prices on a sustained basis, but it probably means the downside is restricted. On aluminium, which is a much bigger market, it is neither here nor there,” says analyst Robin Bhar of Societe Generale.

Bhar says that the program is designed to help the cash flow of the smelters and not the speculators.

About 165,000 tons of copper and 400,000 tons of aluminum could be bought.

“Inventories hanging over the market are mainly bonded warehouses, estimated around 750,000 tonnes, compared with about 300,000 back in end-2011,” Macquarie analyst Bonnie Liu said.

The effect on prices maybe short a source says.

“Domestic prices may rise one or two days only. The market now is over-supplied and demand is far behind supply growth.”

Chief researcher at Citic Futures, Jing Chuan, says that the effect is psychological.

“We saw that in 2008/09, when the SRB buying pushed up prices strongly, although it did not change the real supply and demand situations,” says Jing Chuan.

Coking coal supply seen lower as China shuts down mines

Chinese government has dispatched inspectors to sniff out any potential safety hazards among the nation’s coal mines and shut them down because it aims to have zero accidental coal mine deaths during its political power transition.

“All non-state-owned mines may be suspended even for a very short period. There is no other way to guarantee zero accident,” says Chen Yanyan, an analyst with independent research company in Shanghai.

Chen says that 47% of non-state mines in Inner Mongolia maybe affected and 42% in Shaanxi, meaning that, potentially, lot of coal can be taken off the domestic market in China.

“The latest enforcement of mine closure is much stricter than before. The halt is set to push coal prices higher along with seasonal demand from steel makers,” says Mu Wenxin, senior analyst with, another independent research firm.

As a result, coking coal, used by the steel industry, went up to 1,000 yuan per ton versus 900 on October 29.

These coal mine shutdowns also come as the expansion in Chinese economy looks to be taking hold given the latest PMI reading that is above 50.

There are also additional reasons to be more optimistic on coking coal space.

Steel demand in China has been up since early September and prices have gone up more than 10%. Gains in steel look set to go higher because China looks done dumping its excess in the global markets while infrastructure and housing are expected to ramp up. Housing, for example, may continue higher because banks are issuing off balance sheet loans and the government is looking the other way.

When it comes to coking coal, though, there is also a disparity with the iron ore imports, both ingredients in making steel (details here).

For example, Chinese coking coal imports  were down in September  37.5% sequentially, and that is followed by a 21.7% in August and 3.2% drop in July. These drops come after Chinese imported huge amounts of coking coal in the first several months of the year… so all this implies that the summer was used to work off much of the existing inventory.

With Chinese coking coal inventories lower, demand likely to go higher and domestic supply now being lowered, prices on this steel input, already at the bottom, look set to go higher.

On the conference call in October, Arch Coal CEO said that coking coal (or met-coal) has bottomed out.

“Global coal markets are in the process of correcting, with the domestic thermal market building some momentum while metallurgical markets are bottoming out,” Arch Coal CEO John Eaves said.

Walter Industries (WLT) looks like the best play in the coking coal space not because of its negligible exposure to China but because, as a price taker, it stands to benefit if and when the global coking coal prices go significantly higher.

Walter was highlighted several times on this blog as to how low it could go when the stock was trading in the $100s warning that the stock could drop into $30s. WLT has been in this price range for several months now and indications are that it has established a good bottom in the lower range. All the fundamentals and technicals are pointing that the drop is over and the stock maybe set to move higher.

Early, before the market opened yesterday, it was mentioned on this blog that WLT has several technical features that point to a higher stock price with odds favoring a $13 move higher against odds of a $3 dollar move lower at which point losses could be cut. With a $3 move higher in yesterday’s trading, WLT – a very fast moving name – looks to have more mojo on the upside.

Chinese flat PMI maybe good for coking coal

Latest China PMI report is seen with optimism and  a possible beneficiary of the Chinese bottoming could be coking coal space.

China’s government released Purchasing Managers Index (PMI) rose to 50.2 in October from 49.8 in September, with an output component of the PMI scoring a better 52.1 reading, highest since May. New orders component clocked 50, another 6-month milestone and Markit says that the existing orders took longer to deliver suggesting tightness.

“Survey respondents that experienced longer delivery times attributed deteriorated supplier performance to a rise in the number of orders placed to vendors,” Markit wrote.

The PMI data is seen by many as a signal that China has bottomed out and that, looking forward, surprises on the upside should be expected.

“We believe macro data will continue to surprise on the upside in coming months, as the government continues to ease policy through the period of leadership transition,” says Zhiwei Zhang of Nomura.

“The continued rebounding of sub-indexes including new orders, export orders and quantity of purchases, indicates companies’ de-stocking process has basically ended. We expect China’s economic growth will end its decline and rebound slightly in the future,” Zhang Liqun, a researcher with the Development Research Centre of the State Council, wrote in a statement accompanying the index.

“October’s final PMI rose to an eight-month high, implying that China’s industrial activity continues to bottom out following a modest pick-up last month,” wrote HSBC economist Hongbin Qu wrote.

“We expect a continuation of policy easing to further boost domestic demand and counterbalance the external weakness, leading to a gradual growth recovery in the coming quarters,” says Qu.

Joy Yang, chief Greater China economist at Mirae Asset Securities, thinks that the numbers suggest that there is no rate cut and that monetary policy is done easing.

“Monetary policy has already done its job” and there’s “no way we will see another interest-rate cut because we think inflation is going to rebound,” Yang said.

As a result of the PMI announcement, copper went up a modest 0.6% but a more interesting development will be in the steel making space, particularly in iron ore and coking coal.

During China’s “destocking” period, both of these steel making inputs dived but iron ore has come back as of late while coking coal has been left behind. This “decoupling” of the two main steel ingredients suggests that either iron ore will drop or coking coal prices should rise so given the PMI numbers, odds favor a rise in coking coal prices.

All this could mean that a name like Walter Industries (WLT) could have a meaningful pop after being smothered down into 30s from well above $100 per share.

Indeed, technicals on WLT look extremely favorable with a very bullish divergence during the last 3-month consolidation of the stock between $30 and $40. (another good name is ANR)

The 50 DMA looks like a resistance level now and what happens to the price in the next few days may determine whether WLT pops to $45-47 or drops to retest $30 once again.

Commodity “demand shock” over says BHP

Australia’s giant miner BHP Billiton says that the decade-long mining boom is over because the commodity “demand shock” from China has fizzled.

“In effect, what this means is that the record prices we experienced over the past decade, driven by the ‘demand shock’, will not be there to support returns over the next 10 years,” BHP Chief Executive Marius Kloppers says.

That Chinese commodity demand is dead, of course, is not the first time that BHP Billiton and its mining oligarch partners, Rio Tinto and Fortescue, have said yet while these miners have been flagging the markets that the future price appreciation of what they are making is pessimistic, speculators, on the other hand, have been tackling on bullish bets on some of these metals.

The most often cited reason to go bullish on, say, gold, is because the Fed and other central banks are going loose on money supply.

Statements by these miners, therefore, have broader implications and pit the commodity fundamentals against speculative bursts fueled by liquidity and the outcome of these divergent views is still unclear especially amidst a widespread belief by many money managers that China will soon reignite its robust growth.

As for BHP, the miner plans to mitigate some of the expected price fallout by cranking up output particularly in the hard-hit iron ore. The idea behind the boost in the iron ore production is to capture even more market share and drive its competitors out of the market while maintaining the profit margin with aggressive cost cutting.

“(The) commodity price boom is over and no one can deny it. We’ve now moved to the next phase of the cycle, which is an absolute focus on capacity and cost structures,” Australia’s resources minister, Martin Ferguson says.

Like the price of copper, BHP stock price is at a major decision point with its shorter term moving average approaching the longer-term downward trend.

Based on these charts, odds are that the rift between the fundamentals and the speculators in the commodities may soon clear up.

No crash landing for China says the Fed

While Chinese economic growth is expected to slow the slowdown will not be crash-landing but a more moderate deceleration in growth associated with middle-income trap in some regions that is offset by regions that are less developed.

“China’s relatively undeveloped areas may be able to grow at high rates for some time before reaching income levels associated with slowdown. This could delay a middle-income trap growth slowdown for the nation as a whole,” says the Fed in its latest Economic Letter.

Authors split up Chinese data in the less developed western regions and the more developed, middle income, eastern regions and conclude that the less developed area will continue to grow at an above 7.5% clip and so offsetting the middle-income trap in the east.

Middle-income trap is  situation where the per capita income approaches middle class level so as to make the labor intensive growth model no longer viable.

Research shows that at or near $17,000 of per capita income the middle-income trap kicks in.

In case of the Asian economies, including China, this level is little lower.

“Interestingly, the middle-income trap appears to arise in Asia at lower income levels than has been found for broader groups of emerging-market economies. It may be that large Asian countries with relatively low prevailing wages cause the dynamic of the middle-income trap to shift,” note the authors.

“For example, by 2020, growth in the developed provinces is expected to slow to a still-healthy, but unexceptional 5.5%. But growth in the emerging provinces is expected to remain a robust 7.5%. Thus, China’s overall growth slowdown may not be severe,” says the Fed.

Chinese data seen as encouraging

China’s data on exports are sparking a belief that China’s stimulus efforts are taking hold while data on inflation is seen as providing more room on easing the monetary policy.

Chinese customs data showed exports in September grew 9.9% from a year earlier, about twice the 5% rate expected and up sharply above from the 2.7% annual rise in August.

Consumer price inflation in September reached a new low of 1.9% while producer prices were at 3.6%,  slowest pace in two years.

“Muted inflation pressure will provide more room for the government to introduce additional policy easing or stimulus measures,” says Lu Ting, chief China economist at Bank of America Corp. in Hong Kong.

China is set to report its GDP figures later this week.

Last week, IMF said that Chinese “hard landing is a low probability” but many are looking at China and the emerging markets as a potential source of a third financial meltdown.

Morgan Stanley says that the emerging markets need to rethink export-reliant growth models and pivot to domestic drivers.