November 4, 2013
China's output recovery: is it real or merely window dressing?
Commentary by Senior Market Strategist Robert Balan
«With global demand momentum likely to gradually pick up as the economic upturn in the U.S. and Europe continues and, importantly, domestic demand momentum remaining solid, we expect GDP growth to exceed the government’s “bottom line” in the coming quarters, thus alleviating pressures to stimulate the economy»
Louis Kuijs, Royal Bank of Scotland, November 1, 2013, following the release of the Chinese manufacturing PMI
China’s twin measures of manufacturing activity rose in October 2013, indicating that an economic recovery seen in Q3 2013 is not yet running out of momentum. The official NBS purchasing managers’ index rose to 51.4, from 51.1 in September 2013, an 18-month high. Likewise, the survey from HSBC and Markit Economics (which gives more weight to small businesses) climbed to 50.9 from 50.2. Finally, the non-manufacturing PMI increased to 56.3 from 55.4 the previous month. It does look like this is further good news for the world’s second-largest economy, building on the recovery seen in Q3 2013. But some economists, sifting though the data, suggest the headline numbers do not indicate the real story — the underlying data indicates the possibility of weakness ahead. So we ask: Is it real, or it is merely window-dressing ahead of the November 2013 plenum by the new government of Mr. Li Kequiang?
For us, the October numbers coming out from China can not be viewed in isolation from what is happening in the North and East Asia region's (and even the global) economic context — the Asian regions are experiencing renewed export growth, as typified by South Korea's improvement to 7.3% in October, from 2.3% in September. The last two quarters have seen the growth of activity in the US, Japan, and Eurozone — hence, we expect export numbers from China picking up in Q4 this year, and in H1 2014 — the external data from those regions show up in Chinese numbers two to three quarters later.
There may be some truth to the (unsubstantiated) gut-feeling that part of it may be window-dressing, after the new government relented from the self-imposed constraints on growth earlier in the year. The new government selectively embarked on new infrastructure projects to keep GDP growth from falling below what we believe to be a minimum target of 7.5%. In that sense, we also believe that no "accidents" are allowed to happen between now and the conclusion of the November 2013 plenum — not from the sense of data manipulation but through doing what needs to be done to keep the growth trajectory along the lines that are acceptable.
In conclusion, the pick-up in growth is therefore not window-dressing, but the efforts of a government not to be embarrassed by unexpected consequences of a self-imposed transition from an infrastructure-heavy growth mode to a more sustainable combination of domestic consumption and structure investments. Hence, we believe the Chinese story will continue to sustain micro-data that are linked to a sustainable Chinese growth, and that includes a host of EM economies and commodities in general.
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Main drivers this week
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Commodities and Economic Highlights
Commentary by Robert Balan, Alessandro Gelli, Marion Megel and Alban De Rougé
US tight oil basins are at uneven stages of growth
The tight oil boom in the US has allowed the country to increase its crude oil production from 5.5 million b/d in 2010 to 6.5 million b/d in 2012. North Dakota and Texas have been the major contributors to this supply growth. Nonetheless, these basins are at different stages of growth as reflected by the new EIA Drilling Productivity report.
Indeed, the Bakken shale in North Dakota, the more mature tight oil play, saw its production growth peak in May 2012. Then, it peaked in October 2012 in the Permian basin (TX) and probably in March 2013 in the Eagle Ford Shale (TX), which is the least mature of the mentioned tight oil basins. The Niobrara shale (CO), where companies only recently started to increase drilling, continues to see a rise in production growth.
On the mature basins, it is interesting to see that it is mainly the growing decrease in output from older wells which causes production growth to slow down (rather than a drop in drilling activity), due to the strong decline rates of tight oil wells. According to the EIA estimates, the drop in output from older wells in the Bakken shale rose from –25’000 b/d per month in 2011 to about –50’000 b/d per month between January and August 2013.
This implies that production growth from new fields need to increase at a faster rate to offset the increasing decline from older fields. This is a major problem in the Permian basin where production has only barely increased from 1’278’000 b/d in May 2013 to 1’288’0000 b/d in August 2013 since output growth was offset by the decline at existing oilfields.
Thus, in order for the US to continue to see an important rise in crude oil production, oil prices need to remain at a high level in order to encourage the development of new tight oil plays as production growth from mature plays is expected to decline further.
Libyan issues add more pressure on European refiners
Libya is again making headlines in the oil market as strikes and protests from armed groups led to a reduction in crude oil production. These groups continue to ask for more reconnaissance from the government and a higher share of the oil income. Thus, Libyan crude oil production which stood at around 600-700’000 b/d until mid-October, up from around 300’000 b/d in September 2013 (but still down by almost 50% from April 2013 level), has now fallen below 300’000 b/d, according to the Libyan oil minister on Monday.
Moreover, the situation in Nigeria remains unstable. Shell recently ended force majeur on its light sweet crude oil exports from the Bonny Light terminal. However, oil theft is not likely to halt and further supply disruptions are likely. Both Nigerian and Libyan light sweet crude oil exports are hence likely to remain volatile in the coming months. These factors have contributed to keep Brent oil prices, the major light sweet crude oil benchmark, around $107-$110 during October.
Volatile crude oil exports from Nigeria and Libya are expected to have a more important impact in the coming weeks on the oil market due to the end of the refining maintenance season, which reduces crude oil demand. As the market seasonally tightens, reduced light sweet crude oil supply will add upside pressure on international oil prices. The lack of light sweet crude oil is likely to particularly affect European refiners, which use an important amount of this kind of crude, keeping their margins to an already low level. Thus, the situation should encourage weaker activity and refineries’ closures.
On the other hand, US refiners on the Gulf Coast, which are using a growing amount of domestic light sweet crude oil thanks to the tight oil boom (and the crude export ban), are likely to gain market’s share due to the lower than normal refining activity in Europe.
China’s apparent copper demand hit fourth highest level in September
Copper prices appear to have found strong support near the level of $7,200 a tonne, helped by the confirmation of the Chinese economic revival. The country’s consumption of copper has indeed accelerated in the past weeks, as suggested by the sustained high imports, production volumes, and high consumers’ premiums: net imports hit their highest level since February 2012 at 336.6 thousand tonnes in September, while production reached a record high during the same month, at 620 thousand tonnes. The restocking cycle, which started in the summer, has contributed to drive domestic demand for the red metal upwards. However, the fact that inventories are only rising slowly suggests that there is some strong real, underlying demand backing China’s import and production levels.
China’s apparent demand (production + net imports - change in inventories) has accelerated again in September, rising from last year’s levels for the seventh consecutive month, to 912.5 thousand tonnes. September also rebounded from the seasonal slowdown experienced in August, when apparent demand narrowed to 783.9 thousand tonnes, though still up 12% y/y.
We expect the trend to slowdown a bit in October, due to the holiday week, which should result in lower copper imports. In the longer term however, China’s restocking cycle should continue for another three-to-four months as these phases usually last for about six months. The consumers’ premiums, which have remained near record high at $200/tonne through October, also confirm that the copper market is tight in the Middle Kingdom (as opposed to Europe, where the situation has recently eased). Another indicator suggesting that imports could remain elevated in the coming months is the SHFE—LME price arbitrage (incl. VAT, import duties) which is now back into positive territory, favouring the imports of copper over the domestic buying.
A rebound in corn yield?
For the second consecutive week, the quality of the US corn crop has increased significantly. After a rise of 5 percentage points last week, the proportion of corn rated “good” or “excellent” was revised upwards by 2 percentage points to reach a level of 62%, according to the last Crop Progress report published by the US Department of Agriculture (USDA). This represents the highest level forecasted this season since mid-August.
Once again, the largest increase occurred in Iowa, the biggest growing state for corn. The percentage of corn rated “good” or “excellent” in this state surged by 4 percentage points to reach 49% after a rise of 9 percentage points last week. Fourth-ranked Minnesota and Indiana, expected to have the fifth-biggest crop, experienced also a gain, whereas Illinois and Nebraska, respectively second and third ranked saw the quality of their crop unchanged. These states between them have been estimated by the USDA to produce some 8 billion bushels of corn, which is nearly 60% of the national crop.
Therefore, analysts expect USDA to boost US corn yield in its next monthly WASDE report, which will be published on the 8th of November. Indeed, there is a positive correlation between the quantity of the crop rated in “good” or “excellent” conditions and the yield.
In the September report, USDA estimated the corn yield at 155.3 bushels per acre. As a reminder, there was no report in October due to the US government shutdown. Analysts believe that the new yield forecast could reach 158 bushel per acre, an increase of 1.7%. If we keep an harvested area unchanged, the production could reach a record of 14 billion of bushels, a rise of 30% since last season.
Chart of the week: Gold parameters improving
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Last week, we argued in the Commodities Insight Weekly that silver might lose its lustre as investors could soon favour gold over silver again, considering stronger prospects for the yellow metal as opposed to silver. This trend has gained ground these past days. Gold prices have steadily risen from $1,280/oz in mid-October to +$1,300-1,350/oz last week, encouraged by a much better market sentiment. Despite the fact that, last week, the US Fed cast doubt on its tapering plans, there is more and more economic evidence suggesting that the reduction in asset purchases will only be a 2014-story. Last week, the plunging US pending home sales provided further reason not to expect a tapering in the near term. The declining real long term interest rates, along with a weakening US dollar, also offer a much more promising outlook for gold in the medium term. As far as the sentiment is concerned, the bullish consensus is now 61% positive on gold, from a low at 25% in June this year, the lowest since May 2004. During the uptrend in gold prices, the metal was usually considered oversold when bullish views fell below the 50%-level. Since gold has entered a consolidation phase since September 2011, this 50%-threshold no longer holds. During the period of depressed gold prices from 1999 to 2001, these frontiers stood at 30% and 65%, followed by 40%-80% in the 2002-2003 period of improving prices. On the Comex, the net long non-commercial positions have rebounded this week, back to 110,040 (futures and options) lots, the highest level since early September. Net long speculative positions have only exceeded 100,000 lots on five occasions since gold’s massive sell-off in April. Outflows from the world’s gold ETFs have continued, but at a much slower pace. October 29th even saw a slight rebound in holdings, although this is more likely to be a brief rebound. Holdings are now decreasing at a pace of just 0.4% weekly, compared to a pace of +1% in early October and 1.5%-2.5% during the summer. We expect ETF outflows to slowdown significantly in the coming weeks and moderate inflows to restart by the end of the year. |
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