China PMI not that strong, but may be good for commodities: Clyde Russell

by **Cals** Tue 01 Apr 2014, 13:55

Business & Markets 2014

Written by Reuters

Tuesday, 01 April 2014 12:37

LAUNCESTON, Australia (Apr 1): China's official Purchasing Managers' Index for March probably isn't as strong as it looks, but that's likely not a bad thing for commodity demand in the next few months.

The National Bureau of Statistics (NBS) PMI rose to 50.3 in March from 50.2 in February, matching the consensus expectation and indicating that the factory sector expanded slightly in the month.

The official measure, which focuses more on large, state-owned enterprises, is somewhat at odds with the HSBC PMI, which fell to an 8-month low of 48 in March, its third straight month below the 50 level that separates expansion from contraction.

It's likely that the HSBC survey is painting a more accurate picture of current conditions in China, given the NBS measure tends to be seasonally strong in March, as this is the first month after the Lunar New Year holidays, which this year straddled January and February.

Taken together, the two PMI surveys are showing a Chinese economy that has lost momentum and has had a soft first quarter.

So, how can this be positive for commodity demand in the next few months?

Because the market is betting that the Chinese authorities will return to the tried and trusted practice of stimulus spending, which tends to fall heavily into infrastructure such as railways.

This sort of spending ramps up demand for steel, copper and cement, and increased demand for those commodities in turn boosts consumption of energy and transport fuels.

Premier Li Keqiang has already provided signs that stimulus spending is coming, saying in a speech on March 28 that the government "will launch relevant and forceful measures" to counter a cooling economy.

Li specifically mentioned the experience of last year in battling an economic slowdown, suggesting that this year may follow the same template of ramping up infrastructure spending.

However, it is also likely that any stimulus will take several months for the full impact to be felt, meaning that economic indicators may remain soft for the second quarter, before accelerating in the third.

Demand boost for coal, iron ore

Stimulus spending should boost demand for iron ore and coal, especially if global prices remain weak.

Spot Asian iron ore <.IO62-CNI=SI> has recovered in recent days from its 2014 low of $104.70 a tonne on March 10 to end at $116.80 on Monday.

But it is still almost 13 percent weaker this year, and the prevailing market consensus is that prices will struggle to rally significantly as additional supply comes online in top exporter Australia and elsewhere.

Coal prices at Australia's Newcastle Port, a benchmark for the power-plant fuel, ended last week at $74.07 a tonne, close to the $72.98 on March 14, which was the lowest for almost 4-1/2 years.

The low prices mean there is no obstacle from a cost perspective should Chinese stimulus spending result in higher demand.

In fact, weak global prices tend to result in a loss of supply from Chinese domestic coal and iron ore miners, who have higher costs and lower grades than competitors in Australia and Brazil when it comes to iron ore, and Indonesia and Australia for coal.

This helps explain why Chinese imports of iron ore and coal have remained robust even if the face of slower economic growth and concern about overcapacity in the steel industry.

Iron ore imports in the first two months of this year were 148.07 million tonnes, up 21 percent from the same period last year, while coal imports were just 3.5 percent weaker at 45.47 million tonnes.

It also seems that China is starting to work its way through record-high iron ore inventories, which were boosted by financing deals, with stocks at 43 ports dropping last week for the first time since the week of Dec. 13.

Anecdotal reports also suggest that many small Chinese coal miners are having to cut output due to low prices, which should help tighten thermal coal inventories and increase imports, especially in the light of the low global price.

For commodity producers, the Chinese demand story appears to be largely intact, with the current weak prices and the potential for stimulus spending likely to keep import volumes healthy, especially for third quarter cargoes.
(Clyde Russell is a Reuters market analyst. The views expressed are his own.)