Why #China’s commodities demand is different - FT Alphaville

Very interesting comment on the future consumption trends for soft and hard commodities in China.

Why China’s commodities demand is different
A lot of optimistic projections for China’s commodities demand look something like this:

See the charts online.

The premise is fairly straightfoward: you take the country’s current level of GDP per capita, and compare its steel (or whatever) consumption per capita to what other nations’ consumption levels were at that point, and how fast they subsequently rose.

The chart on the left adjusts for… well, we’re not sure really, but the chart on the right gives a very clear hint to Rio Tinto investors that they can expect great things to come in terms of Chinese demand for iron ore.

At the same time, we can be pretty sure that China is moving away from its unusually capital-intensive economy towards a more balanced, consumption-heavy economy. If it’s not happening already, it will happen. China’s consumption is a lower percentage of GDP than any of the comparison countries above.

And what this means for the western companies selling stuff to China? Depends what line of business they’re in.

Consumer-focused businesses, in theory, would have more to gain than industrial ones.

This is the line taken in a WSJ story on Monday, which looks at the recent rash of disappointing Chinese revenues for several big foreign companies in Q1: Caterpillar, ABB and Vale. Meanwhile, Apple, Starbucks, Mead Johnson (which makes baby formula) and Pernod Ricard are seeing Chinese sales surge, says the story.

This is an interesting theme; and one that’s familiar to us via the reasoning of Michael Pettis, who has long held the view that China must and will rebalance, and that this rebalancing will lead to a price collapse for hard commodities. Earlier this month, he wrote:

Non-food commodity prices are set to collapse over the next three to four years. “Collapse” is not too strong a word. China’s share of global demand for such commodities as iron, cement, copper, etc. is completely disproportionate to its size and almost wholly a function of its very high growth in investment. As investment growth drops sharply, as it must, global demand for non-food commodities will plummet.

In other words, most commodities will still be in strong demand. Hard commodities, not so much.

So we were curious to see a note from Barclays last week — co-authored by some of the same strategists who posited that China is already rebalancing — which made some interesting projections of the rate of demand growth for various commodities. In a nutshell, not all food commodities are going to see ever-growing growth rates:



The Barclays authors write that even in the past, China has not been the commodities-intensive economy that it is often characterised as:

The true picture is much more nuanced. Relative to its size China is using less energy and smaller amounts of many industrial commodities, such as steel and copper, than other nations did at similar levels of development. However, its consumption of other commodities, especially foodstuffs, is considerably higher. This suggests that its development path is more resource-efficient than that followed by many other Asian countries before it, but that the dietary shifts that have characterised the development of other countries in the region may be happening earlier in China’s industrialisation process.

This is their evidence:

See the graphs online.

Which is not actually very helpful because when Japan, Taiwan, South Korea were at the $8,000/capita stage of their economic development, it was different times, right?

Yes, the Barclays analysts write, it is different — these are the main reasons:

- price incentives: some commodities are more expensive now, hence the incentive is to use less of them.

- scale of export markets: China is so much bigger than Japan, Korea, and Taiwan (to stick with the most-used comparisons). All have followed export-led development paths, but the sheer size of China means that export markets make up a smaller proportion of its output.

- they export different things: South Korea for example exports a lot of cars.

However, the 2008 stimulus kind of threw things out of whack for normal trajectories, especially regarding steel:



The Barclays analysts write:

Many of the factors that have supported recent improvements in commodity intensity in China may turn out to be temporary, especially with the influence of the 2009 stimulus fading fast and China now aiming for a less investment-intensive, more consumer-led growth model, as outlined earlier in this report. The slowdown in GDP growth led by lower growth rates in infrastructure and property investment, the policy goal of further reductions in the energy intensity of the economy and a greater focus on reducing pollution and improving the environment all suggest a lower intensity relative to GDP for some commodities in future.

However, other factors such as continued rapid growth in urbanisation, rapidly rising living standards and increased demand for consumer goods are likely to act in the opposite direction.

Digging into the consumption side of demand actually shows some counter-intuitive results: for example, the Chinese consumption of calories per head already exceeds that of Japan. Although, as the table on the left (below) shows, that’s partly because the Japanese have what looks like atypically healthy diets. In terms of calories from fat and protein, China still has a ways to go to catch up to South Korea or indeed the developed world average in terms of calories from fat, but it’s already hit the developed world average (which is of course affected by the likes of the US) for calories from protein!



In our view, the only circumstances under which China is likely to experience further strong growth in its per capita calorie consumption levels is if the population adopts a western-type diet similar to that of the US, for example, where average daily calorie intake is 3,770, roughly 26% above China’s current level, and protein consumption is about a third higher. If such a change does  take  place,  however,  it  is  likely  to  do  so  only gradually. A much more likely scenario is for Chinese diets to remain close to those of their Asian neighbours as income levels converge. If, as appears to be the case, China is close to saturation levels in terms of its per capita food consumption and its uptake of calories from  those food groups associated with higher incomes, then the key drivers of China’s agricultural commodity demand over the next 5-10 years will be population growth (likely to be modest), the use of grains in the manufacture of processed food (eg, corn starch and sweeteners), and any growth that occurs in the use of crops for fuel.

We do not expect any of these factors to result in strong growth in the quantity of grain or meat consumption. More important trends are likely to revolve around growing demand for higher quality, fresher foodstuffs, as well as changing tastes and preferences within different food groups. Whilst the quality of the average Chinese diet is likely to gain significantly over the next five years, quantities are not.

The report looks at a whole lot of other factors affecting China’s future commodities use, such as the expansion of “smart grids”, increased wealth, and expanding renewables use.

But, to cut to the chase: here are their forecasts for winners and losers:

See the graphs online.

Related links:
The supercycle is so over – iron ore edition – FT Alphaville
Steel demand is endless – FT Alphaville

This entry was posted by Kate Mackenzie on Wednesday, May 2nd, 2012 at 8:42 and is filed under Commodities. Tagged with china, Chinese economy.

Read the article online here: http://ftalphaville.ft.com/blog/2012/05/02/983441/why-chinas-commodities-demand-is-different/


FT Alphaville » Why China’s commodities demand is different