Macquarie Research comments that “at this stage in the global economic downturn, it is worth highlighting the still-dominant role that China has had and will likely continue to have in demand, supply and pricing. For the most part China has had a surprisingly strong positive impact on commodity markets due to stronger-than-expected demand and also weaker domestic supply growth.

“In many commodities, the world outside China is still experiencing a dramatic destocking cycle with apparent demand still experiencing year-on-year (yoy) falls in the 30-50% range. By contrast, Chinese apparent demand has started the year in a relatively buoyant mood with only aluminium of the main commodities recording a year-on-year decline in the first two months of this year:

“The Chinese trend continues in the bulk commodities with China becoming a bigger importer of coking coal and iron ore and a smaller net exporter of thermal coal this year. Data from exports show that China is now a dominant factor in exports of coal and iron ore from Australia and in January-February, Brazilian exports of iron ore to China rose an amazing 50% yoy while exports to the rest of the world combined fell by 689% yoy.

“In many markets we look at, China has gone from an average of 30-35% of the world total in 2007/08 to 40-50% in the first quarter of 2009! In iron ore, China was 50% of the seaborne market in 2008 but may well be 75-80% of the market in the first quarter of 2009.

“There are a number of elements in this remarkable strength of China in the teeth of the biggest global

economic slowdown in a generation. They include:

• China is restocking, while the rest of the world is destocking – apart from government stockpile purchases (reported at 300,000 t in copper, 590,000 t in aluminium and 203,000 t in zinc so far this year), Chinese traders and consumers also appear to have restocked steel and iron ore (iron ore port stocks have risen 11.2 Mt since mid-February and trader and producer stocks are thought to have risen by 15-20 Mt since the start of this year). The restocking is partly speculative (buying ‘cheap’), partly for strategic reasons and partly for local industry support reasons. In addition, we think there may well have been some buying ahead of anticipated consumption growth from the Chinese government stimulus package
• Chinese high-cost/unsafe domestic production is falling sharply. In recent years, due to major shortages, Chinese producers brought on exceptionally high-cost production to meet its internal demand. As demand and prices have fallen and freight rates have declined, higher-quality/lower cost imports have become competitive and Chinese domestic producers have curtailed production. This is definitely the case in zinc/lead (where Chinese mines are currently running 50% plus below 2008 peak levels), iron ore (current production at 250 Mt/y down from 400 Mt/y at its peak) and coking coal (domestic production around 100 Mt/y below peak 2008 levels due to closures for safety reasons). Chinese production of aluminium and alumina has also fallen sharply from mid-2008 peak levels (25% below peak) and Chinese nickel pig iron is running over 50% below previous peak levels.

In addition, in copper, Chinese imports of copper scrap have collapsed due to lower scrap generation overseas and lower copper prices decreasing economically-recoverable scrap in China and overseas.

Arguably, these factors have supported many commodities prices above levels which they otherwise would have fallen to. In copper, the Chinese factors may well have added $0.5/lb to prices, in coking coal, the surge in Chinese imports may have added 30% to the recent settlement price, while iron ore spot prices would have been substantially lower if Chinese domestic producers had not curtailed production; the recent rally in freight rates (although now fading) was solely due to the surge in Chinese imports).

The Macquarie report concludes that “the short-term risk is that unless there is follow-through consumption strength in China, some of these gains may well erode. Already in steel and iron ore there are signs that destocking may have started (reducing demand and shipping rates), while Chinese copper demand could falter if the Chinese withdraw from markets following the recent price surge.

“The bullish scenario is that this Chinese surge lasts until destocking finishes outside China and the Chinese stimulus package starts to kick in.

“In any case, the Chinese numbers for many commodities have surprised on the upside so far this year, just as the rest of the world continues to surprise on the downside.”