Part 2: Mood darkens as we ventured through the smog

Days 4-5: Jinan and Shanghai


Janet Mui

Janet Mui

Global Economist

China found itself at the centre of a storm during the summer when concerns over the health of its economy sparked the biggest one-day sell-off that global markets have experienced for years. 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 and their prices.

I spent a recent five-day trip in China with a focus on the industrial commodity sector, in search for any silver linings and signs of bottoming in prices. My trip further confirmed our cautious sector view. The mood was bearish amongst the producers we met, with over half of the domestic coal, aluminium, steel and iron ore industries incurring losses. After completing meetings with management teams across a range of sectors, it is hard to see any near-term solutions for the problems that China faces – namely overcapacity and sluggish demand. The bearish tone was observed across the majority of company meetings we went to. The worrying part is the fact that this is being met with relative inaction from state-owned enterprises (SOEs).

After completing three days of meetings in the industrial centre, Shenyang, and the seaport of Qingdao, I continued to Jinan, the capital of the Shandong province.

Firstly, I met with a truck company, which had an extremely bearish outlook. The management team noted a 60% fall in year-on-year construction-related truck sales. They remain pessimistic even if there is a moderate pick-up in construction because they expect developers will use existing trucks instead of ordering new ones.

The truck company is an SOE and will therefore not cut its labour force. On the positive side, like other SOEs, it is benefiting from lower interest rates.

I then met with a steel company, where, once again, I was greeted with negativity. The management team noted serious excess supply and expect a further decline in steel prices.

As a result, it is focusing on higher ‘value-add’ products, such as military equipment and wind power. On the plus side, it has seen a pick-up in orders related to government-sponsored infrastructure projects.

The property sector in this lower tier city is in a dire state, as the company has received no new orders for construction projects this year.

The next leg of my journey took me to an SOE aluminium producer, which expects prices will remain low for some time. Despite claiming to be efficient and a beneficiary of policy support, it is only breaking even – this is perceived as being very good versus 90% of its peers, which are loss-making.

Like other SOEs, it will continue to increase capacity and will not cut headcount – despite the headwinds. It simply hopes to prosper as a result of other non-SOEs going out of business. It really does appear to be the age of the ‘invincible SOE’.

All of the companies I met with view a strong US dollar as a continual headwind.
I finished my trip in Shanghai, where I met with an auto company. It noted poor sales in the first half of the year. Auto sales in October rebounded, but this was mainly due to tax incentives and is unlikely to last.

I also took the opportunity to visit a property analyst. He has a bearish view looking ahead to 2016 because he believes a recovery is only happening in tier 1 and 2 cities. This accounts for only 4% of the volume of new housing sales.

Even after factoring in future rate cuts and lower mortgage requirements, he forecasts negative year-on-year housing will begin next year. Nationwide, the housing market has already peaked.

In contrast with this negative outlook, a meeting with a Shanghai property developer confirmed just how “hot” the city’s property market is. While I was there, two entire blocks of apartments were sold in one day. The developer expects Shanghai house prices will continue to rise, driven by the large numbers of immigrants in the city.

In my view, government easing is helping tier 1 and 2 cities disproportionately.

My conclusions

Our sense is that supply will take a long time to adjust as SOEs are unwilling to cut production and smaller players are being kept alive by local governments for employment reasons, alongside local banks, hoping to delay bad debts.

There is too much vested interest in keeping factories running in this irrational environment and excess supply won't be cleared over the next three years.

Not a single company that I met with has seen any kind of recovery in prices. No-one can highlight a meaningful supportive driver for growth or commodity prices. In my view, infrastructure construction cannot offset weaker property construction.

Crucially, we need to see if new housing starts turning positive and how the US tightening cycle unfolds.

Accordingly, we believe that industrial commodity prices have yet to bottom. We think that although the room for substantial price falls is more limited now given the significant adjustment over the past few years, there remains a lack of supportive drivers for a recovery. The balance between weaker demand and a steady increase in the supply of industrial commodities suggest that the industry will experience a continued glut, leading to a lower-for-longer price scenario.

As gloomy as the smoggy weather, it is very hard to find a silver lining to the situation of secular downfall of the “old” China and industrial commodity prices.


Janet Mui

Janet Mui

Global Economist

Janet Mui, CFA is the global economist at Cazenove Capital, the wealth management division of Schroders. Janet is responsible for the formulation and communication of Cazenove’s top-down views. She is a member of the investment committee that oversees strategic and tactical asset allocation at Cazenove. Janet is also the macro spokesperson and a regular commentator at major media outlets including the BBC, Bloomberg and CNBC.

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