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Nov 2008 - China Impressions

Impressions of China Depend on What You See

In the first two weeks of November 2008, we visited China looking at prospects in Guangxi and Yunnan in the first week, followed by the annual China Mining Conference with ~3,700 participants held in Beijing in the second week.

During that period, China announced its Rmb4trn stimulus package, a number of expectations were given at China Mining, and we saw a range of areas from growth to quiescence. So it was not surprising in some way, that on our return, two major international brokers/banks reported that they had recently returned from 2 weeks in the China region and were reducing their metal price expectations by 25% or more, which has had a knock-on effect on share prices.

For an impression of what’s going on in China, it really depends on where you go and what you see, and for Beijing..........it depends on what day. During most of the time we were in Beijing, the city was shrouded in fog/smog partly due to the industrial smoke chimneys in front of the hotel belching out pollution as shown in Figure 1. The conference hotel is almost within a stone’s throw of the Olympic Birds Nest Stadium, so those industrial plants must have been closed when the olympics were on.

However, there were also some clear days. In fact the weather started to clear significantly to a blue sky with the mountains at the end of the streets, and on the day we left to go to the airport it was crystal clear (but then it should be, after all it was minus 6 degrees C and windy). On the way to the airport we saw 4 crane factories of apartment blocks under construction, whereas only one week before, we had been unable to see anything apart from the smog.

In the vicinity of the hotel, most of the cafe’s and the nearby shopping mall were empty of people, and an impression could be formed that hard times were really impacting on China too, especially if you read some of the media showing factories closing in Shenzen etc. However, the reason for the absence of people in the nearby cafe’s was probably that they were still using olympic prices.

A bowl of beef noodle soup cost Rmb28 to Rmb55 in the cafe’s there, compared to Rmb10 in a fast food cafe in central Beijing, or Rmb4 in a street cafe adjacent to Golden Tiger’s offices in Nanning (Guangxi). (Divide Rmb by 4 or 5 to get 1A$). Stroll out of this area to the Birds’ Nest and there were many many crowds of people arriving on coaches to spend Rmb50 just to walk into the central stadium and look at the middle green.

At Wangfujing shopping street in central Beijing, with its low priced night market snack foods, it was choc-a-block with people shopping (after business hours) and many Chinese people carrying boutique shopping bags (not Europeans).

Basically, the Chinese middle (and upper) classes are becoming increasingly affluent, which is why when combined with the serious shortage of physical gold (coins and bars) outside of China and consumption figures of 50t on an Indian festival day or 140t reputedly purchased in Saudi Arabia, that we don’t see the gold price collapsing to average US$690/oz in DQ08 or US$630/oz in MQ09.

With the coming Chinese New Year of the Ox (let’s face it, it has been a “rat” of a year), from 23 January 2009, and usually regarded as more auspicious while requiring hard work, the Chinese have those great fabled new year sayings (if you are a gold bull) such as “Gold should be seen everywhere in the house”. So in our opinion the gold price should remain above US$700/oz.

Further signs of the growing affluence in China were the Porsche’s being driven in Nanning (black of course), and a Porsche showroom there. Apparently, the largest dealership for Bentleys is now in China, and in 2007 the 9 Bentley dealerships spread throughout the country, sold 258 of them. Also in 2007, China contained 7 of the 10 Bentley Mulliner 728s which cost ~Rmb12m each.

Apparently Xian (the old money location) in Shaanxi Province, also reputedly has a high demand for Rollers too (106 sold in China in 2007). BMWs, Audi’s and Mercs (again all still black) have become commonplace throughout China amongst the various forms of 4WDs.

At the conference it was stated (in the zinc section, in answer to a question) that auto sales were falling and were only expected to increase by 15% in 2009, down from the 20% increase in 2008 and 24% increases in 2006 and 2007. Which highlights one of the problems with statistics, namely it depends on your viewpoint. The 15% increase in 2009 means that new auto sales are expected to be 13.8m in 2009, compared to 12m in 2008 (being up 2m from 2007’s 10m, or more than double the inferred 6.5m sold in 2005). And all new cars are to be compliant with Euro emission level 4 for autocatalysts, with a gradual phase out of older cars to reduce pollution.

Although China’s Rmb4trn stimulus package over two years to 2010 is designed to return the country to a growth rate of 9%pa, after it dipped to 8.2% in October 2008, it should be recognised that it is only part of the ongoing programme. As only ~Rmb700bn is for rail (33bn for Tianjin to Qinhuangdo, 100bn for Xinjiang to Humi/Linhe (an east-west lateral line), 220bn for 10 railway lines in Hebei and 350bn for the Yangtze River Delta).

The rail programme is following the now largely complete road programme that has occurred over the past 5 years and it is now possible to drive on freeways for 550km straight from Nanning in Guangxi to Zhujie in Yunnan (which was the turnoff for a country town about 50km or so away, that then went to a mining operation that I visited).

The MD of Golden Tiger commented that he recently visited Xinjiang and travelled on the freeways there for about 12 to 14 hours per day each day for about 4 days or so. All the new dual carriage freeways in China look the same with their side crash barriers – a statistic given was that each km of a standard freeway uses >500t of steel (sounds like a lot), >5,000t of cement and ~2,000t of asphalt.

As for railways, currently 150 projects are in progress throughout China involving Rmb1.6trn, and 9,700km is expected to be under construction at the end of December 2008 (at an average cost of Rmb100m/km). With 10,000km per year scheduled to be constructed in 2009 and 2010, that is about Rmb1trn per year. The original 2004 plan was to build 120,000km of rail by 2020 at a then perceived cost of 5trn, but costs have risen. The railways were estimated to require 20mt of steel in 2009.

China Rail has about 2.1m formal employees and hires about 2m migrants for construction per year. With the accelerated construction programme the migrant requirement could more than double. While a number of toy and shoe factories have recently closed in China, the blame was not being made on the credit crunch, instead it was placed as being due to a combination of rising wages, rising raw material costs, and the stronger Rmb (up 20% against the US$ in the past 3 years), which has caused owners to move to cheaper areas, like India.

New subways are being built in Hangzhou and Chengdu, while in Beijing another 240bn has been allocated to extend its subways from the current 110km to 240km by the end of 2012. The recent construction of Line 10 in Beijing cost almost 14bn for its 25 km length (or 550m/km). Construction on lines 7 and 14 has started, while line 15 is to connect to the Summer Palace. There is also a country-wide recommendation that all cities of >4m people should have a subway to avoid congestion.

It has to be recognised that the 9% target rate is an average for all the Provinces. Some of the Provinces will have higher rates, for example, construction in Nanning City is still flat out (it does not appear to have paused) at about 16%pa, while at Baishan City in Jilin, is reputedly ~19%pa. Whereas Beijing and Shanghai may only be ~5%pa, and the 430bn allocated to rebuild the earthquake damaged areas in 470 projects in Sichuan is obviously going to have a significant impact.

Of the remainder for the 4trn package, it has been allocated to roads, port upgrades, energy (including 2 new nuclear power stations), Chongqing industry, and a housing upgrade for 7.47m low income families in the Lingbo/Zhejiang area. And as with the rail expenditures, these amounts are simply part of the whole programme.

So China having achieved an average growth rate of 9.8%pa for the past 30 years, may achieve its 8% to 9%pa targeted growth rate, financed without the rest of the world (ROW), and if that is enough for the rest of the world to survive on, then OK, and if not, well it’s the ROW’s problem as China has its vision of where it is going and how it intends to get there. Iron ore imports were expected to remain unchanged at 435mt in 2009, with steel only increasing by 3% to 5% in 2009, after the 6% to 7% in 2008 and ~30% rise in 2007.

However, it also has to be noted that China has insufficient ore resources (yet alone higher quality resources) to achieve its targets and intends to provide finance or take significant positions in companies or country’s orebody’s to achieve its goals (especially for years 20 to 40). If that results in higher metal prices then so be it, but as stated in the conference, it was deemed right that producers should make reasonable profits, not excessive profits.

Disclosure and Disclaimer: This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is an Authorised Representative with Taylor Collison Ltd, and with his associates, may hold interests in some of the stocks mentioned in this article. The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

Figure 1. Beijing, China – Impressions of China depend on what you can or cannot see.GDNnov08

  • Written by: Keith Goode
  • Saturday, 01 November 2008