Full report: A research trip to one of the (smoggy) heartlands of industrial China

The implications of the deceleration in industrial activity for commodity markets

China is at the forefront for both the production and consumption of industrial commodities. On the supply side, China is by far the world’s largest producer on coal, aluminium, alumina, steel and zinc. On the demand side, China accounts for almost half of the world’s industrial commodity consumption. China has become the largest importer of metals, with its share increasing to 46% from less than 10% over the past decade. In 2014, almost half of metal exports were coming from Australia, Brazil, and Chile to China. Accordingly, China is an extremely important driver of industrial commodity prices, which has had a significant impact on certain commodity producing countries. Notwithstanding this, China is a much smaller player in the global oil and gas sector, from both a demand and supply perspective, and therefore plays a less important role in determining energy prices.

As China re-focuses its growth from fixed investment to consumption, the country’s lower “new normal” growth has led to a slump in demand for industrial commodities, such as copper, aluminium and steel. To date, the supply response has been limited which has resulted in a structural overcapacity amongst producers and persistent weakness in industrial raw material prices in recent years. What is next for industrial commodity prices? Are we near the bottom of the industrial commodity cycle? Will China’s stimulus measures help generate a recovery in demand for industrial commodities in 2016 and beyond?

To help develop an understanding of these key market themes, I visited remote areas in the North-eastern part of China – which, arguably, is at the epicentre of recent weakness in China’s industrial sector. This was not a trip for the faint- hearted. It was face masks on as we were shrouded in smog in some of China’s most polluted cities during the coal-burning season. On the other hand, being a Mandarin-speaking economist, I was able to gain a fuller understanding of some of the deep problems facing companies in a core industrial zone.

We visited key Chinese commodity producers1 and heavy industrial companies in Shenyang, Qingdao and Jinan. To help develop an understanding of the financial implications of recent weakness in the manufacturing sector, we also met with banks and real estate developers in Shanghai and Beijing. Aside from the usual management meetings, we had informal chats during site visits, during which we heard candid expressions from people who have spent their whole careers in these sectors and businesses. Our report provides an alternative assessment of recent developments that is unlikely to be read in brokers’ research or official statistics.

Conclusion – lower prices for longer

Following the trip, we have become even more cautious on the outlook for the metals and mining sectors. There was a surprisingly strong consensual pessimism amongst the companies we met – not a single company was expecting industrial commodity prices to recover in the foreseeable future. The most common response to questions was that excess supply will persist and the adjustment process will be very long. Most executives said that rebalancing supply and demand could take two to three years, with some suggesting it could take three to five years. No company could identify any meaningfully positive drivers of industrial commodity demand or prices.

The sense we got was that the weakness in industrial commodity prices is far from over. Although the likelihood of further substantial price falls is less now, given the significant weakness already seen, there remains an absence of drivers for a recovery. The evident imbalance between demand for and potential supply of industrial commodities suggests that there will be ongoing weakness in most areas, leading to a lower-for-longer price scenario.

1A list of companies we visited can be found in the appendix.


 Contents of the full article:

- Introduction

- Conclusion - lower prices for longer

- The supply glut - Darwinism missing

- Demand - when stable is not enough and flat is the new up

- Interesting quotes from company executives

- Appendix - list of companies visited


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This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.

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