Over the coming quarters, we believe that industrial metals and iron ore demand could be supported by an acceleration in Chinese GDP growth. Over the medium term, urbanization-led property demand and the construction of social housing should also unleash fresh demand for construction materials and effectively set a floor for prices, in our view. In contrast, measures to fight air pollution, strict targets to cut overcapacity, increased use of steel scrap as well as a property tax could result in a peak in steel consumption intensity and lower demand growth for iron ore over the coming decade. As China moves from an FAI to a consumption driven economy and continues to move up the value chain, we believe that metals which have higher usage in consumer applications (including aluminum and zinc) and are required to produce high value added materials such as stainless steel (nickel) and galvanized steel (zinc) are likely to benefit.
Furthermore, our China economics team highlighted that there are recent indications that China may join the TPP (Trans Pacific Partnership) negotiations, which will eventually replace the role historically played by the WTO. According to their model, the cumulative real GDP enhancement for China from joining TPP is 2%. However, the impact on commodities is likely to be two-fold in our view. The domestic metals & mining sector is likely to struggle due to more intense import competition after the removal of import duties (Figure 2). However, as uncompetitive high cost producers (for example aluminium and iron ore) cut production; this should encourage China's imports and thus tightening global market balances.
Eoin Treacy's view China has developed a dominant position in the industrial metal
sector over the last decade so the internal machinations of its economy have
a bearing on pricing. What has become evident over the last year is that industrial
metal prices have for the most part been rangebound with outperformance by copper
and tin due to individual characteristics of those specific markets.
As a result of the challenging environment for pricing, a significant number of the industrial metal miners have also been confined to medium-term ranges. It is therefore notable that Rio Tinto broke out of a three-month consolidation this week and a sustained move below the 200-day MA would be required to question medium-term scope for continued higher to lateral ranging.
An additional perspective can be found in the chart posted on the second page of the above report. China accounts for more than 70% of iron-ore demand but only 10% of sugar demand. Even taking different culinary tastes into account, China's per capital consumption of what is an addictive condiment still has significant growth potential. This suggests that consumer demand growth, not least for convenience foods, may be a more attractive long-term story than commodity demand growth. This has certainly been evident in the outperformance of consumer related sectors in China's stock market over the last few years.