May 8, 2012
May 7, 2012
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
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
May 4, 2012
TSX Venture Exchange...Buy or Sell? Junior #Gold #mining stocks, why we may be close to a bottom
Tags:
mining stocks
Junior mining stocks , where are we and why we may be close to approaching a historical bottom for mining stocks.
The TSX venture is down 45% from the March 4th, 2011 high ( this is the second worst of 7 bear market corrections). Now in 2008, the TSX declined 78%, the worst in its history. Yet commodities are holding much better this time.
On average the corrections have been -36.25%.
Fear and capitulation may create a buy opportunity soon.
TSX Venture Exchange...Buy or Sell?
Fellow investor,
The TSX Venture has been the worst performing stock exchange in North America for over a year now.
For many companies on the TSX Venture, this is a time period filled with anxiety; much like it was in late 2008, the Venture has fallen to the hands of panic sellers. Investors are scared and have been thinking illogically for several months now. Companies that were being bought for $1.00 per share with heavy volume, just 12 months ago, are having a hard time finding bids in this market for $0.30. Volume and risk appetite have vanished. Again, this is similar to how it was in December of 2008 in that respect.
It's funny how quickly the psyche of investors can change. And this latest correction in the TSX Venture (a 1 year collapse in value of roughly 45%), is a testament to how powerful emotions are when it comes to moving markets.
This latest correction is the second worst (from a percentage standpoint) in the TSX Venture's history - yet commodity prices remain at historically high levels and the Dow continues to shake off all negative macro-economic data.
Venture investors are scratching their heads as to why this is happening.
The truth is that the TSX Venture has always been a boom/bust exchange. It's extremely volatile. The exchange has existed for 11 years and during that time, it has gone through 7 bear markets of its own (market downturns of 20% or more).
Let's think about the global economic situation for a few seconds. What has really changed in the last 12 months that would cause the Venture to lose 45% of its value?
Last year we were all well aware of Europe's debt crisis and the potential for it to spill into other countries. We were all well aware that America's national debt was skyrocketing out of control. We knew inflation was going to hit the world in a meaningful way (good news for commodity plays), but didn't know exactly when. We knew China's growth was going to temporarily slow down. Commodity prices were flirting with record high levels. Unemployment in the Western World was historically high. What's changed?
The answer is nothing. Uncertainty has hung around the market for a couple years now. The only thing that has changed is the date on your calendar. We are living in just as uncertain times as we were in April of 2011. As mentioned, this hasn't bothered the Dow Jones. It has continued its ascent to flirt with record highs. Meanwhile, the TSX Venture, an exchange that is heavily weighted in commodities, and more specifically, mineral exploration, has collapsed.
If you had been living under a rock for the last 12 months and woke up looking at a one year chart of the TSX Venture, you would make the assumption it has fallen because gold, copper, silver and oil have probably dropped in value at a rapid rate. This is of course, not the case. Sure, gold and silver have come off their record highs in 2011, but they still remain at historically high values. The miners of these two precious metals are making record margins. Fundamentally, that is fantastic news for the TSX Venture and the explorers which trade on the exchange. However, the reality is quite different than fantastic. Share prices of these exploration companies have been decimated over the last 12 months. This sell-off has been entirely fear driven. Uncertainty and long-term unknowns, in respect to many of the largest economies in the world, have taken the risk appetite out of the markets and left the Venture alone at the bottom of a dark hole.
Fear has taken over the TSX Venture and the last time that happened, the greatest buying opportunity of our lifetime knocked on the door.
The TSX Venture is Trading at the Same Level it Did Nearly 9 Years Ago
In October of 2003, the TSX Venture Exchange traded at the same level it does today. What's important to note about October 2003 is that gold traded for roughly $380 an ounce - it trades 425% higher today. In October of 2003, silver traded for about $5 an ounce - it trades 600% higher today. In October of 2003, a barrel of oil traded for $30 - it trades 320% higher today. In October 2003, Comex copper traded for $0.92 - it currently trades 415% higher.
Aside from these commodities trading near record highs (the main commodities the 1275 explorers/miners on the venture are drilling for), it has become increasingly difficult for explorers to make economic discoveries. Many of the world-class deposits are being mined right now because of the record high prices. Simply put, there isn't nearly as many world-class commodity assets on the globe as there were in 2003. So wouldn't it make sense that these companies, with proven discoveries, be valued higher in this market environment?
Fortunately for us bottom fishers, 'risk' has become a dirty word. This mindset has resulted in fire sale prices on many great investment opportunities within the TSX Venture Exchange.
As everyone already knows, the TSX Venture is predominantly a mining and commodity based exchange. Its value, historically, has risen and fallen with the price of commodities. There are 1,275 mining/exploration companies on the TSX Venture alone - no exchange on the planet even comes close to that amount. It's the 'go to' exchange when looking to invest in the next major discovery.
Looking Back on The TSX Venture's Many Downturns and the Amazing Opportunities That Have Always Followed
The TSX Venture is no stranger to volatility and sharp corrections. It's a small-cap exchange comprised mainly of exploration companies - both early-staged and advanced.
The exploration companies on the Venture don't cash-flow, that's not what they're about. These companies are about making discoveries and being bought out, or years later going into production and then cash-flowing. When a company doesn't cash-flow and only drills, it must regularly go to the market for financings. This creates uncertainty and volatility. This creates the fear factor we are seeing in the market right now. During uncertain times, investors are fearful that many companies on the Venture won't be able to raise capital and could potentially dissolve. This, in most cases, is an irrational fear. Many companies have deep pocketed management teams which can raise capital in any market. Some companies won't need to raise capital for another 2 years. Let's not forget that we recently came off the greatest rally in the TSX Venture's history (December 2008 - March 2011) and the fundamentally sound explorers were able to raise major cash at much higher levels than today. Many of these prudent juniors are sitting on several million dollars in their treasuries from previous financings.
Let's also not forget how nimble these junior explorers can be when hard times hit. These companies don't have hundreds of employees on the payroll. Drillers are typically on contract work and many of these junior explorers have a dozen full-time workers or less. A junior with a burn rate of half a million dollars a month can quite easily cut that down to $50k by stopping drilling during a down market. After all, as you will soon see, a typical bear market for the TSX Venture only lasts 5.8 months anyway.
Because of the Venture's capital intensive business models (particularly with its 1275 mining/exploration companies), it should come as no surprise that this exchange has experienced 7 bear markets (a correction of 20% or more) in its 11 year history.
Ten Year Chart for the TSX Venture - source: quotemedia.com
History of Major TSX Venture Corrections And What Followed
(I define a major correction as a 20% decline or more in the overall TSX Venture Index)
The TSX Venture officially formed in 2001. Its starting value was 1,000.
The TSX Venture's first major correction began on June 4, 2002 after it hit 1,244 (at that date it was a new all-time high). By October 30, 2002, it had bottomed out at 899.30 (losing 27% of its value). This marked a nearly 5 month long correction (downtrend). After bottoming out on October 30, 2002, the TSX Venture went on a 16 month rally and peaked out on February 17, 2004 at 1,931.61. This marked a 114% rally from bottom to top over that 16 month period.
The next significant correction occurred from February 17, 2004 through to July 27, 2004. This was when the exchanged collapsed from 1,931.61 to 1,467.59 - a modest correction in comparison to what we are seeing today. Over that 5.5 month period, the TSX Venture lost 24% of its value. However, once it bottomed out on July 27, 2004, it proceeded to go on an 8 month rally and touched 2,040.29 on March 7, 2005. This marked a 39% gain for the TSX Venture in that 8 month period.
The next significant correction was short-lived. The TSX Venture Exchange dropped from 2,040.29 on March 7, 2005 and bottomed out on May 17, 2005 at 1,593.63. This marked a 2 month decline of 22%. It was quite a vicious decline considering how quickly it happened. However, once the correction bottomed out, the TSX Venture went on a monster rally. After bottoming on May 17, 2005 at 1,593.63, the TSX Venture went on a 12 month rally to 3,292.49 (hit May 11, 2006). This marked a gain of 106% in a year.
Following that massive rally, the TSX Venture collapsed from 3,292.49 on May 11, 2006, to 2,322.48 on October 4, 2006. This marked a 5 month decline of 29.5%. However, following that correction, the TSX Venture rallied to all-time highs. It hit 3,369.79 on May 7, 2007. This marked a 7 month gain of 45%.
The next significant correction, after the TSX Venture hit an all-time high, was short and vicious. The TSX Venture went from 3,369.79 on May 7, 2007 to 2,445.23 on August 16, 2007. This marked a 3 month decline of 27.5%. However, following that correction, the TSX Venture rallied to 3,173.64 on November 6, 2007. This marked a 3 month gain of 29.5%.
The next significant correction was the worst any of us have ever seen, but it set up a golden rally for those that stayed at the table and kept buying. After hitting 3,173.64 on November 6, 2007, the TSX Venture went on a 13 month decline and bottomed out at 686 on December 9, 2008. This marked a 78.3% decline over a 13 month period. Great companies with world-class assets were deemed worthless by the market. What a mistake that turned out to be for those selling anywhere near the lows. After the TSX Venture bottomed out, it went on a 27 month rally and hit 2,439.83 on March 4, 2011. This marked a 255% gain in just over 2 years - the greatest rally for any of the major markets in North America during that time period.
The next significant correction for the TSX Venture is the one we currently find ourselves in. Although there was a short-lived rally at the start of 2012, the downtrend in the TSX Venture has been steady since March 4th of last year. Since hitting 2,439.83 on March 4, 2011, the TSX Venture has collapsed down to as low as 1333 on October 4, 2011 (it has been bumping along the bottom ever since). That marks a 45.5% decline from its March 4th 2011 value. That also marks the 2nd largest drop in the history of this exchange. Now, given that we have been bumping along near the bottom of this collapse for 7 months, one can argue that 'this time is different'. However, every time a market crash occurs, that argument is brought to the forefront.
Those are the statistics behind the 7 crashes the TSX Venture has experienced in its 11 year existence. Crashes and rallies are a part of its genetic make-up. No one will deny that it's a boom/bust index and if timed well (doesn't have to be perfect), it can make investors fantastic returns in very short periods. This is what will keep investors coming back to the TSX Venture - the greed factor. Let's look at the TSX Venture's historical averages:
Average loss (in percentage terms) during a correction (peak-to-trough): -36.25%
Average duration of a bear market in the TSX Venture: 5.78 months
Average gain after a correction (trough-to-peak): 98.08%
Average duration of a bull market in TSX Venture: 11.83 months
It can be argued which stage the Venture is in for its boom/bust cycle right now. However, historical statistics are showing us that at these levels, the Venture is looking like a buy. There is no doubt that volatility is going to be around for a long period of time (for all stock exchanges), but that isn't necessarily a bad thing.
Inflation is good for the value of commodities and the TSX Venture exchange is heavily weighted towards exploration companies. With growth stalling world-wide, global stimulus is inevitable in my opinion. QE3 will come in one form or another. Japan is already adding to its stimulus programs. The ECB has stated that more easing is needed and China is weighing options for further stimulus as well. With the UK officially entering a double-dip recession, it's likely to continue printing. This is all good news for commodity based investment.
Let's not forget about what tax season can do for smaller, illiquid stocks (ones that trade on the Venture). It's often overlooked, but the end of April is when personal income tax is due. Quite often at this time of year you'll see more pressure on the smaller exchanges because individuals need to cover tax burdens. Individuals (specifically the self-employed) are scrounging up some extra cash to pay the tax man right now.
Another bullish point to consider is that we are approaching drilling season for many explorers. Companies have either started drilling or will be soon thanks to the warmer weather and all the money raised over the past 18 months (which were strong periods for financings).
Drill results are coming...new discoveries are a guarantee in the next 3 months. The advantage for people like us is that we can get in before these results are produced; and we can do so for nearly 50% cheaper than 12 months ago.
An interesting statistic I found on the TSX website (TMX.com) was that "total financings raised in March 2012 was up 182% compared to February 2012 [for the TSX Venture]."
Could this be a sign that the smart money believes a bottom in the Venture has been established?
Rick Rule, one of the most successful junior resource investors on the planet, recently wrote an article titled "Why I'm Excited About This Gold Market".
Rick stated "As experienced junior gold speculators know, nothing adds to share value like discovery. Speculators will fondly remember hundredfold profits from discoveries like Diamond Fields and Arequipa. We are now truly in a discovery cycle, one fueled by sustained capital investments in unprecedented amounts. Better yet, we have been able to explore frontier terrain that was off limits due to politics or social turmoil. This will add spectacular real value, and this prospectivity is discounted in the current market."
He goes on to state "First, recognize that markets work, but only in the longer term. If you can't handle that, find another avocation. The cure for low prices is low prices; the cure for high prices is high prices. In order to sell high, you must buy low. What is the appropriate response to a strong market? Sell! What is the appropriate response to a weak market? Buy! Be a contrarian or be a victim."
As Rahm Emanuel said "A crisis is a terrible thing to waste."
Happy hunting.
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