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Feeding China’s Commodities Dragon

Chinese demand for commodities is racing ahead of production, leading to pricing inflation and demand-supply imbalances that could jeopardize the stability of the global supply chain, according to research firm {complink 7065|Standard & Poor’s} (S&P).

The strong Chinese demand for major commodities is not expected to ease off anytime soon, despite the government's efforts to cool down the economy. This means prices for key commodities, including those used in the production of high-tech equipment, will continue to rise globally, boosting profits at suppliers but also pitching manufacturers against manufacturers, nation against nations, and injecting sometimes misleading forecast numbers into the supply chain.

Commodities suppliers aren't losing any sleep over China's rising demand for their products. In fact, the biggest suppliers are swimming in profits after prices surged to record levels in recent years. Fueled in part by sharp Chinese demand, prices for aluminum, copper, crude oil, gold, steel, and rare earth metals used in many electronics products have raced to new highs over the last few years.

Commodity prices have moderated slightly over the last several months due to concerns global economic growth might be slowing, but they are still above historical levels. In April, S&P estimates showed copper prices soared to a record $10,000 per ton, more than quadruple the $2,000-and-a-bit per ton from 20 years ago. A great chunk of the increase was a direct result of surging demand from China, which in 2010 expanded its consumption to about 7.6 million metric tons from 3.6 million tons five years earlier.

“As a consequence, China's share of total world copper consumption has risen dramatically, reaching 39 percent in 2010, from about 22 percent in 2005, and China is now the world's largest copper-consuming country,” S&P said in a report entitled “The potential risk of China's large and growing presence in commodities markets.” The report, available to subscribers, can be downloaded here.

Copper is not the only commodity where China is now the dominant consumer. In 2010, Chinese consumption of aluminum jumped to 43 percent of global demand from about 13 percent ten years earlier, putting the country ahead of the United States. In the steel market, China accounts for 42 percent of worldwide consumption in 2010, according to S&P. It also now accounts for 60 percent of global iron ore consumption and 52 percent of coking coal demand.

Finally, China's demand for crude oil is racing well ahead of domestic production. “In 2010, China was the world's second-largest oil consumer, accounting for about 10 percent of world demand, after the US, which accounted for 22 percent. China met only 45 percent of its crude oil requirements internally in 2010, and it is now the second-largest oil importer after the US,” S&P said in its report.

Why should any of this trouble anyone? And why should anyone in the electronics industry be concerned that Chinese demand for commodities is rising so steeply? In fact, shouldn't the electronics industry be happy China is able to secure the raw materials required for keeping high-tech production lines humming? I'll let Standard & Poor's make the case for why you may want to pay attention:

    China's growth as a consumer of commodities has had dramatic ripple effects across world commodities markets — straining supplies, causing prices to soar, spurring production capacity expansion projects, and setting in motion a wave of mergers and acquisitions.

    With commodities prices having been at or near record levels earlier this year, Standard & Poor's Ratings Services is naturally concerned that the current situation represents an unsustainable bubble, subject to a sudden correction. And if current market conditions in commodities do represent a bubble, a significant deceleration or downturn in China and other emerging economies could ultimately cause the rupture.

As in previous times of supply-demand disequilibrium, the research firm is concerned commodity suppliers are currently more focused on the “market strains resulting from having to 'feed the dragon,' ” and do not appear worried that “a rapid deceleration of China's consumption of those commodities could quickly leave the global market beset by excess supply.”

I can understand that. Why worry about a problem that seems quite unlikely to materialize? That said — this industry has been burned numerous times before by failure to heed signs demand is overheating.

29 comments on “Feeding China’s Commodities Dragon

  1. Houngbo_Hospice
    June 28, 2011

    Hungry China devouring commodities on her way to becoming the world first economy might be both a threat and a blessing to the world. The blessing goes to developing countries that will sell their commodities at competitive prices and the threat is about the fact that “'feeding the dragon” might mean a drastic reduction of the world's natural resources. 

  2. mario8a
    June 28, 2011

    HI

    Aluminium prices it's been very stable over the last years even when the demand increased, but how about Neodimium ( magnets) This year the price increased more than 400% in the consumer market.

     

    Regards

  3. Barbara Jorgensen
    June 28, 2011

    Strip away the word “China” and the scenario you describe suits the 1999-2000 technology bubble perfectly. The tech market was surging with no end in sight and orders were being fulfilled without question. The drop was sudden and painful and devastating for many companies. I hope this isn't “same story, different day” but many of the trends are the same.

  4. hwong
    June 28, 2011

    Especially with the Japan's disaster, it will need to be rebuilt pretty soon. Japan does not have alot of natural resources. As a result, it will look to nearby countries for the material such as steel and aluminum. This will reinforce the demand for commodity

  5. hwong
    June 28, 2011

    Especially with the Japan's disaster, it will need to be rebuilt pretty soon. Japan does not have alot of natural resources. As a result, it will look to nearby countries for the material such as steel and aluminum. This will reinforce the demand for commodity

  6. mario8a
    June 28, 2011

    I think Japan did not have many resources even before the disaster, that's why a watermelon is so expensive over there.

    The law of the offer-demand applies everywhere anytime, and if is not happening the supplier/vendors will force it.

    Ps.

    I remember one guy had a tire shop repair and created some damage on the road two blocks before and after the shop location,  can you imagine what big companies will do to get customers pay more for their goods?

     

    Regards

  7. Mr. Roques
    June 28, 2011

    WOW… those numbers are amazing, China is simply too much. And it's continuing to grow. 

    I don't think the soaring prices help developing countries, they simply help the suppliers but overall a developing country could use cheaper steel, etc for it's own industry. If it *has* to export everything because the prices are simply to high to not take advantage of them, the domestic industry will lack supplies.

  8. Houngbo_Hospice
    June 28, 2011

    ” If it *has* to export everything because the prices are simply to high to not take advantage of them, the domestic industry will lack supplies.”

    Hi Mr. Roques,

    The problem is that there are hardly  substantial domestic industries in such developing nations and their only means of survival is to sell the countries' raw resources overseas. Maybe they should preserve such recourses for future use. But most of the leaders in developing nations seem to just be thinking about the present. 

  9. FLYINGSCOT
    June 29, 2011

    Any system that grows too quickly will inevitably overshoot and drop as the system corrects itself.  As such I expect the boom will be followed by a bust of some sort.  Another interesting thing to consider is the effect Chinese investment in other countries will have on local economies.  Increasingly China is acquiring commodity supply companies (like mines and processing plants) in many other countries and instituting Chinese style work practises there.  This could upset local balances and disrupt local economies.

  10. jbond
    June 29, 2011

    With China's frenzy on commodities, along with many other developing countries, it would appear that alternative sources are needed and needed soon. Some of these commodities will disappear soon and unless we come up with alternative ways to meet our demands we are going to have serious global ramifications. Take copper for instance. Copper is the main conductor of electricity used for wiring worldwide along with aluminum. Copper is the better choice. If the supply gets too expensive or dries up, how are things going to get wired in the future? This is just one example of how we need to look at alternatives since growth is inevitable. 

  11. Taimoor Zubar
    June 29, 2011

    Any system that grows too quickly will inevitably overshoot and drop as the system corrects itself.  As such I expect the boom will be followed by a bust of some sort.”

    I agree with this statement, however, the natural correction mechanism takes its due time. With the rapid demand by Chinese companies of certain commodities, this can create scarcity of these across the globe. Certain commodities may be essentially required in other areas other than the electronics industry. This may include healthcare industry or pharmaceutical industry. I think it's important to intervene here so that the shortfall of these commodities do not affect other industries.

  12. Ashu001
    June 30, 2011

    Bolaji,

    This statement here is really the only part of the report which makes sense today,

    With commodities prices having been at or near record levels earlier this year, Standard & Poor's Ratings Services is naturally concerned that the current situation represents an unsustainable bubble, subject to a sudden correction. And if current market conditions in commodities do represent a bubble, a significant deceleration or downturn in China and other emerging economies could ultimately cause the rupture

    Commodity producers are pouring billions into Expansion projects and suddenly there is no demand.As you rightly point out this is a problem which has burned them repeatedly in the past.

    Looks like its time to get burnt again.

    Regards

    Ashish.

  13. Ashu001
    June 30, 2011

    Bolaji,

    As usual the folks at S&P are far,far behind the times(&especially with regards to fundamentals).

    I have no problem with the report if the Demand coming out of China is genuine.But unfortunately if you look at some numbers like Fixed Asset Investment as well as Debt levels;it becomes crystal clear that this is another Debt fuelled bubble which is just building up excess capacity all over China.It is now being said that there is a cubicle for every single Chinese Citizen in China.Which clearly shows how excessive  the Commercial Real estate bubble has become in China.

    If Real estate is the primary demand driver(for all these commodity imports) then its about to hit an extreme soft-patch like no other very soon.

    Also,a significant amount of Copper imports are just going to stockpiles and warehouses of the Speculators who are speculating on higher and higher prices.

    And then(when this bubble bursts) things are not going to be pretty.

    Regards

    Ashish.

  14. Ashu001
    June 30, 2011

    Mr.Roques,

    Its all a Debt fuelled frenzy.Not going to last for a longtime.Thing is most demand coming out of China is not backed by Fundamental demand but rather by two seperate forces-

    1)Speculation

    and 2)Government Command and control(with consistent misallocation of capital that is the hallmark of all Govt spending).

    For instance,take a look at the Chinese proposals to build maglev trains all over China.The Cost-Benefit ratio as well as the Economic Multiplier effect for these trains is very low(compared to Conventional Express trains(with Diesel/electric locomotives or Aircraft or even Automobiles).

    Still it gives the Chinese Communist party a massive ego boost(to brag that they have the longest Maglev lines in the world);even if its actually an extremely unaffordable albatross which just loads more debt on Local and Central Govt shoulders…

    If these train tickets were priced for ROI (its usually 10-15 years for Infrastructure projects of this scale);then hardly anyone would use them.

    Regards

    Ashish.

  15. Ashu001
    June 30, 2011

     

    Taimur,

    How would you intervene?

    Would you build stockpiles in place in most Consuming countries(like we have with Oil in the US,UK,France,Germany,Japan-THE IEA)

    or,

    would you push extra funds into research for alternatives?(like Japan is doing today with Rare earth metals which have surged to untenable levels thanks to China's total domination over exports of rare earths)??

    Would be great to hear your thoughts on this issue.

    Regards

    Ashish.

  16. garyk
    June 30, 2011

    It Looks and Sounds like CHINA is at WAR with the free world. iT LOOKS LIKE A MANUFACTURING WAR. First they control all the conract manufacturing then they control all materials, Oil, Steel, etc.

    Is CHINA the only country in the world that has acid rain?

    I understand in the manufacturing cities in CHINA, the air quality is very bad from the industrial pollution. Maybe CHINA has a very large contribution to the Global warming issues? Should the Global Warming scientist be addressing the pollotion issues in CHINA?

    What about the DAMS being built on the Yangtze River, could this causing climate change? It's OK, lets just keep feeding the DRAGON.

     

  17. stochastic excursion
    July 1, 2011

    How many of the products manufactured in China belong to companies owned by the Chinese?  Most of the investment going into Chinese factories comes from elsewhere in the globe.  In light of this, Standard and Poor's singling out of China as having a voracious appetite for commodities is more than a little nonsensical.

    Commodities are being consumed because there is a demand for the products at the end of the assembly line.  Constraints on the supply of raw materials naturally drive up cost–very little speculation in this case, just cause and effect.  When demand drops as a result, a stabilization will ensue, no bubble.  The costs are driven by intrinsic not speculative value.

  18. bolaji ojo
    July 1, 2011

    @Stochastic Excursion, If only the research firm was just interested in how China's voracious appetite for commodities was indicative of its overconsumption. That's not the case. I believe Standard & Poor's is more concerned about the dislocation within the demand-supply system. If Chinese demand falls dramatically then suppliers will get hit hard. That's what the research firm is concerned about. But the concern expressed is not something to worry about. It offers manufacturers the opportunity to understand better how to prepare for, anticipate and strategize against market imbalances.

  19. stochastic excursion
    July 1, 2011

    I see that Chinese manufacturers, acting as a single concern or affected by some unforeseen event, could destabilize the commodities markets.  Another “what if” for suppliers to worry about.

  20. Mr. Roques
    July 29, 2011

    Exctly, there's no local industry… but maybe it's because steel is so expensive! 

    It's a question of policies, and maybe a 10-yr strategy. Build local industries with the local supplies (no export) and after that, export to the current market price (which will be higher because of scarcity – due to the local-only policy).

  21. Mr. Roques
    August 25, 2011

    Well, it might be speculation BUT it's raising the price. We'll have to see how long it takes them to realize it's simply too much.

    In the mean time, smaller countries have to sell everything they have to China, hurting their growth.

    Thanks for your analysis.

  22. Ashu001
    August 26, 2011

    Roques,

    Nobody's forcing anyone to sell.The Smaller countries are doing it because they need the cash for Govt spending.

    Regards

    Ashish.

  23. Ashu001
    August 26, 2011

    Roques,

    That is exactly the china modus operandi.

    And its worked out very wel for them so far.

    Regards

    Ashish,

  24. Ashu001
    August 26, 2011

    Bolaji,

    That makes perfect sense in the context of looking at how Commodity cycles develop.

    Boom and Bust is very much the hallmark of these cycles.The Analysts at S&P realise that and are just trying to warn enough people in the hopes of smoothing that cycle.

    Too bad people don't realize it (and keep screaming this time is different) again and again and again.

    Maybe Commodity Bulls should just open their history books.

    What do you think?

    Do you think Manufacturers have what it takes within themselves to,


    It offers manufacturers the opportunity to understand better how to prepare for, anticipate and strategize against market imbalances.


    Ashish.

     

  25. mario8a
    August 26, 2011

    Hello

    I guess in terms of feeding Chinas Commodities, China is facing a bigger problem, their economy is getting stronger and it will become less attractive for invesment, few Years ago their R&B was 8 to 1 against the US dollar, Now is around 6 to 1, what this means is that investors will have to spend more money to make bussiness with China, what is forcing to look else where.

    seems like soon we will have an ew player on OEM / ODM partnership.

    regards

  26. Mr. Roques
    September 14, 2011

    I know they aren't being forced, in the strick sense of the word. But when we think of developing countries, in most cases, we should also associate it with lack of long term vision and that makes them think that they money they can get now is what matters.

    If a govmnt has a careful plan, it might realize that it's better for them to not export something and have it, at a lower price, to promote local industries. If not, they will only have the $ obtained from the sale, no long term progress in that.

  27. Mr. Roques
    September 14, 2011

    It's interesting to see how that plays out. Insourcing started taking importance a few months ago but an article in EBN later told us that it won't live for long.

    China NEEDS to slow down according to some economic analyst. 

    Who do you think can take China's place? India?

  28. Ashu001
    September 18, 2011

    Mr.Roques,

    Countries are slowly but surely adapting this route.

    I see Countries like Chile and a few nations in Africa sign deals along these lines only.We will give you the Commodities but in return you have to give us Roads,Dams,Bridges and Schools.

    Its a Win-Win for all concerned.

    Regards

    Ashish.

  29. Mr. Roques
    October 28, 2011

    Interesting partnership… it definitely makes sense. Countries need to understand that investing in their own infrastructure might be the best investment they can make (something Korea learned early on). 

    If they decide to sell their minerals and get cash or bonds, while it's money — maybe they won't know how to invest it efficiently (and end up losing part of it in bureocracy – to say it nicely).

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