Is China running out of steam?

During 2010 we seem to have moved back into another commodity price boom, with all major commodities, from oil to metals, grains and of course sulphur all heading back to the kind of price levels last seen in 2007-8.

Much of the rise in markets has been sustained by activity in the developing world, especially China, where the economy surged forward last year. GDP has grown by 10.3% in 2010, up from 8.7% in 2009, with strongest growth in 4Q 2010 and projected to go forward into 1H 2011. The Chinese government has actually become concerned by the pace of growth and taken steps to try and throttle back the economy, raising the standards for bank lending seven times in an attempt to ease back the flow of credit, and it is forecast that interest rates may have to begin to rise soon. Some people in commodity markets have become concerned by this, saying that 2011 will be a year of “downside risks” and bear markets. Costs are rising in many commodity markets, they argue, as producers must pay for development costs in local currency but sell in dollars, a currency that has weakened against many currencies – especially the Chinese yuan - over the past two years. The fear is that the Chinese economy is trying to expand too quickly and will soon fall victim to its own success, bringing the current commodity boom down with it.

Needless to say, others take a different view and say that fiscal moves in China will merely prevent overheating, and that Chinese demand remains robust. Among the bears, Danske Bank’s 2011 Commodities Report argues that we are still on the upswing of a 40-year demand-driven ‘super-cycle’ in commodity markets which last peaked in the mid-1970s (driven in the 1950s - 70s, it was argued, by post-war economic growth in Europe and Japan, and finally curtailed by the Oil Crisis) and which hit its trough around the turn of the millennium as markets were flooded in the wake of the collapse of the FSU and Eastern European economies. Seen in these terms, it argues, 2008 was merely a short-term correction to a continuing prevailing upward trend, now driven by Chinese (and to a lesser extent Indian) industrialisation, which may not peak until some time between 2015 and 2025. The super-cycle was an idea which gained a good degree of popularity in commodity markets in the 2005-08 period, was quietly brushed aside during the recession, but seems to be gaining traction again.

Certainly the future for base metals appears to be tighter markets and higher prices. Copper in particular is singled out for more record pricing – probably topping $11,000/t. Stocks to consumption ratios on the London Metal Exchange are standing at a historical low of 2.3 weeks and deficits are, according to some commentators, becoming “structural”. On the agricultural side, too, while wheat is roughly in balance, there are low stocks on the corn side – just 16% of annual demand and well below the 20-40% range that is generally considered a balanced market.

The impact on sulphur is harder to predict, dependent as it is upon various other commodities. But as we discuss in Sulphur in this issue, China’s hunger for copper has led to a major increase in sulphuric acid production from smelting in the region, while the buoyant nickel market is gradually having the reverse effect by driving increased acid consumption in leaching projects. Record phosphate prices continue to feed into sulphur demand for agriculture, but high oil and gasoline prices have driven major investment in refining capacity and increased sulphur production. Overall the pressure seems to be on the upside rather than the downside, and China has certainly become an engine of the sulphur market – in 2009 it imported 12.1 million tonnes, and the figure for 2010 will probably be 10.0 – 10.5 million tonnes. Sulphuric acid production was up 20% over the year. So far this has sustained sulphur prices in the range $165-175/tonne, and producers around the world are presumably making hay. The indications seem to be that China’s boom has at least a few more years to run, even if its sustainability in the long run is more open to question.