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Nov 2015 - One Belt One Road

OBOR (One Belt One Road) but not in China's GDP.

While the western world presenters at China Mining's October 2015 conference in Tianjin focused on standard supply and demand forces holding back commodity prices, the Chinese presenters focused on the new normal (of lower commodity prices) and OBOR (One belt one road).

For iron ore, CRU thought that Rio's production recovery could pull iron ore prices back to $50/t by the end of Dec 2015, with iron ore remaining depressed based on lower steel demand expectations for China in 2015 and 2016 before recovering in 2017 back to $55/t and gradually increasing to $70/t by 2019. Wood Mackenzie were about  the same but with a possible short world recession in 2018.

The general comment was that there is no China 2, so basically any perceived slowdown in China results in extending excess supply. China dominates the metal markets with 2015 estimated demand (US in brackets) in Aluminium 49.7% (9.6%), Nickel 51.8% (7.9%), Zinc 47.7% (7.9%) and Copper 46.0% (8.4%). And that's why LME week earlier in  October 2015 was apparently so gloomy. With a still wobbly recovery in the ROW and so many varying negative forecasts on how Europe is recovering (with the Syrian ingestion) and the pace of the US recovery.

Only Australia was positive due to the low A$, which could was hoped by some to weaken further based on weaker commodity prices, and hence further support prices in Australia.

World GDP growth was expected to pick up to 3.4% in 2016 (from 3.0% in 2015) even if China drops back to 6.4%, in part due to Russia's expected turnaround driven by China. Copper was seen as flat at $2.30/lb with reductions in supply by Freeport etc stabilising any production increases. In fact most metal price forecasts were flat for 2016 at about current metal prices, largely because the models are based on GDP and pmi forecasts being heavily weighted to China, with prices then recovering in 2017 from growth outside of China.

However, China was promoting heavily on the basis of OBOR. One Belt One Road which is the re-installation of the silk route by land and by sea as shown in the Figure.

 OBOR affects 4.4bn people (~63% of the world's population), ~81,000km of the Eurasian rail network, ~29% of the world's economy at ~$21trn, ~26 countries and regions, and ~24% of the world's goods and services exports. OBOR was expected to require $8trn in infrastructure as China rebuilds the stans (road then rail) along with Russian infrastructure (initially oil and gas pipelines) partly in return for mineral rights / resources. Russia has allocated its poorly developed eastern Russia to China for mineral exploitation, while Kazakhstan has granted many tenements in its mineralised areas. Such areas take time for discoveries to be made and brought into production.

The problem/issue is that none of this construction is going to be reflected in China's GDP, and hence may not have any impact on metal prices.

China is currently constructing ~5,000km of rail in Ethiopia, of which its most recent was a ~700km link between the north and the capital, following a ~30km light rail link in a major city in Ethiopia. If the rail and rolling stock (locos, carriages etc are manufactured in China and shipped to Ethiopia where they are offloaded and used,  it goes in China's GNP (not GDP). If China sends "metal" that it has produced from ore processed in China and exports it for manufacture in Ethiopia, then it is not recognised in anything.

 So any construction that China is involved in worldwide outside of China (new Silk Road routes, Africa, South America [there is a proposed rail route on the Pan Pacific highway through Chile and Peru built by China]) is not in China's GDP. But nevertheless involves metal consumption imported into China. (Which explains why China has not turned any ships away, everything is offloaded. Stockpiles at current prices, simply become low cost, relatively cheap, mined ore sources. China does not have to use its stockpiles yesterday, due to ongoing construction demand.

There is also the CAREC (Central Asian Regional Economic Co-operation) programme upgrading six transport routes (initially road) to international standards in the "stans" comprised of a block of countries that include : Pakistan, Afghanistan, Kyrgyzstan (actually now a republic), Turkmenistan, Kazakhstan, Tajikistan and Uzbekistan. The CAREC programme includes ~$28bn worth of projects in 2015, that were due for completion by 2017, and in which China is strategically involved as part of its 2011 to 2020 programme.

Kazakhstan, aided by China is hosting a number of major conferences building up to a mega world expo at Astana in 2017 on "future energy" to be held over 3 months affecting ~100 countries, an anticipated 3 to 4 million passenger trips, and possibly ~1bn Euros of foreign investment with new buildings, new roads and a new urban rail system.

China is involved in nuclear energy construction in Kenya and now the UK, to add to the electrical construction taking place in 2015 in Azerbaijan, Bangladesh, Indonesia, Turkey and Vietnam, and that is besides the extensive construction occurring in Africa.

It was commented (yet again) that China's GDP numbers are just numbers, and the current flaws in China's GDP are the variable weightings applied each year (ie different weightings in different years - in 2014 the services sector was ~47%, now it is ~51% (ie 10% higher). Also real estate costs based on RMB/yuan per sq metre and that then weighted by each capital, province etc. China's GDP number is released just a few days after a quarter - ie the GDP numbers are just numbers, and the variable weightings in each year mean that, a year eg 2015 may not be strictly comparable to that of a previous year, eg 2014. But they are being used as a basis by traders for metal prices.

Service sector growth, though, has been spectacular in China, up 8.6% in SQ 2015 (apparently the highest since 2011), with Apple's growth in China up 99%, Alibaba retail earnings up 48%, Baidu (China's Google equivalent) up ~120% to $9.5bn for its transaction services.  It is no wonder that China now has more billionaires in US$ terms than the United States. China added 242 billionaires in the past year, resulting in 596, whereas the US only has 537.

China has a lower threshold to its own "rich list" set at 2bn yuan for which there are 1877 individuals (up 606 in the past year) who hold a total wealth of $2.1trn. China's top 3 are Wang Jianlin & family of the Dalian Wanda group whose wealth increased by 52% in the past year to $34.4bn, Jack Ma & fam of Alibaba is at $22.7bn, and Zong Qinghou & fam of Hangzhou Wahaha is at $21.1bn.

I asked someone in CRU based in China . "How come I see so much construction in China (~36 crane multiples or crane farms on the way from Beijing to Tianjin and the new CBD extensions east of Guomau in Beijing), but it doesn't appear to impact GDP ?" To which the reply was you need all that construction to keep the current pace going - don't forget it's what was going on last year plus now this year. And once its completed its finished, as in onto the next one.

Tianjin is still relatively booming with its GDP for the first three quarters of 2015 at 9.4%, and it expected to benefit from becoming China's first FTZ (free trade zone) in the north (complementing the other FTZ's in Shanghai and Guangdong), along with the urbanisation growth corridor being established from Tianjin to Beijing to Hebei; besides the Yangtze River growth corridor.

I also asked what happens to all the weaponry as far as GDP is concerned (China had just had a mega military parade which was shown on almost all the train journeys I undertook this year - I actually didnt realise are so many different types of tank). Anyway, no - it's a state security secret  - all military metal consumption is not included in GDP.

One session that I attended (SE Asia Mining) contained a very surprising segment, in which China made it very clear that if countries don't help it to achieve its aims, the business is likely to go elsewhere to countries that are more accommodating.

A Mines minister from Thailand came in for a "serve" when he was asked when was approval going to be given for the high speed rail link and the canal. The canal being the short-cut route through the Gulf of Thailand, which would bypass going via Singapore. After the reply, the Thai minister was cut off, as was the representative from Burma, although Laos was able to present, but then also came in for a historical "battering" by a retired person on how much they had been "ripped off" operating in Laos.

Both Australia and Canada were classified as high risk (mining wise) for the monies that had been lost there, and were noticeably not included in the opening forum. Apparently in Canada, a project was bought for $4bn in 2011 and sold 3 years later for US$50m. Peru however was allowed to present in the opening session and highlighted how it expected to benefit from OBOR, although China regarded Chile as No 1 for investment in South America.

In Indonesia, China is starting to roll out its metal unit refineries with the first Aluminium 15kt refinery due in mid-2016 (assuming the power station is completed on time), then the first 20kt nickel refinery in 2017 (the nickel refineries are added as 20kt units costing ~$200m to $300m each, with the next in 2019 and the last in 2022 for a total of 80ktpa nickel). The Aluminium refineries total 60kt - and that was just Hanking's ones.

Although not elaborated on that much there appeared to be an increasing focus on recovering metals from tailings / recycling with it mentioned in the keynote opening MLR (Ministry of Land and Resources) speech.

Amongst the base metals, copper was seen as probably the best bet, simply because China only produces ~1/6th of its requirements domestically. In fact it was commented in a presentation that ~83% of China's copper requirements are imported, along with ~57% of its crude oil, ~57% of its bauxite and ~56% of its iron ore.

As for gold, its expected range for 2015/2016 was still ~$1100 to $1400/oz, although it should be recognised that $1050 is probably still $1100 from China's viewpoint, with the recent fall to ~$1085 on 6 November 2015 probably a retest of Comex vs Shanghai as in who does control the gold price. At $1100/oz about 30% of China's mines are apparently uneconomic. At $1000 it is reputedly ~ 50%, so gold was not expected to go down to $1000.

And China wants the gold, mines can close in other commodities, but not gold. It is well known that at low prices, China's uneconomic gold (and other) mines don't stop. The workers are paid in rice, and then get back pay when profits recur, and/or gold mines are reputedly subsidised in an arrangement between the majors and the smaller barely economic operations.

China's demand in 2015 was expected to exceed 550t of gold. But as with most statistics it depends on what it includes, with the WGC having China's gold demand at 497t in 1H2015 (ahead of its 3Q15 release on 12 November), and 974t (or 886t) for 2014. Shanghai's "demand" for the year to mid Sept 2015 was for example 1890t of gold, but as per WGC, includes other movements.

China's gold "reserves" (of its official storage area) are being reported on a  monthly basis now (one of the IMF requirements of reserve currency status), and is increasing by 15t to 19t of gold per month. But there is still debate over what China's banks actually completely hold as some also group gold into their "currency" holdings.

The RMB/yuan was expected to become a reserve currency in the next IMF meeting in October 2016 (the 5-year decision on what currencies form the SDR (special drawing right - if the world ever went to a world currency it would be SDRs) was delayed by one year from 2015, and when that delay occurred, China devalued. Until the 2016 decision, China knows that it has to support the US$ because the US has a veto vote as to who can be allowed to be a reserve currency in the SDR.

The other catalyst for gold (as far as I am concerned) is the US election, as in the Dow appears to be being kept up because the Democrats probably don't want it to fall ahead of the next election - far better to potentially blame it on the Republicans (post election after 8 November 2016, and if/assuming that they get in). Post the election the US$ can then fall too, it would dovetail nicely with its historical pattern of 6 years up, 10 years down - 2016 would be 6 years up after the previous fall.

As for the rest, coal was glossed over, uranium was perceived to be undersupplied with China having 23.34GW of nuclear capacity and an additional 25.2GW under construction. And oil and gas was to be fed from the pipelines being constructed (mostly through Russia), with an increasing chunk of energy coming from China's own shale gas discoveries. Oil itself was like most commodities expected to drift sideways between $45 and $55/bbl during the remainder of 2015/16.

It appeared to be very clear that commodity prices were mostly expected to simply drift in 2016, especially if the traders continue to partly mis-guide their focus on China's GDP as the key guideline for growth and commodity demand, thus allowing China to continue to consume and use ore at relatively low prices.

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 a Financial Services Representative with Taylor Collison Ltd (AFSL 247083).

Figure. OBOR by land and sea (there are variations, such as a direct Turkey to Germany link)

fig1 nov 15 obor copy

  • Written by: Keith Goode
  • Sunday, 01 November 2015