By John Richardson
THE wheels have started to come off the wagon – as we have been warning about over the past week or so – as a result of a broad sell-off in equities and commodities.
Inflation concerns in China and elsewhere, the result of all the hot money flowing into emerging markets due to QE2, dominate as investors seek to minimise risk.
And maybe the new Asian hedge funds we talked about early last week are now ready to swing into action, shorting all sorts of markets and accelerating the downward declines.
We can just about guarantee that we will also see sharp retreats in petrochemical pricing – exposing as flawed some of the reports that recent rallies have been justified by strong demand.
As regular readers know, we keep our closest eye on polyethylene (PE) pricing – now in the case of linear low-density (LLDPE) just another financial instrument in China.
And sure enough as the Shanghai Composite Index suffered a 1.9% decline on Wednesday to follow its 9% fall in Monday and Tuesday, the Dalian Commodity Exchange slipped again.
The most widely traded LLDPE contract on the Dalian at the moment – the one which closes in May next year – fell by a further 615 Yuan on Wednesday following a 440 Yuan fall on Tuesday.
Discussions with major PE and monoethylene glycol (MEG) producers earlier this week revealed that these two companies were expecting and were prepared for price declines.
They were able to see through some of the more dubious claims about the reasons for recent market rallies. Let us hope that they are not alone.
“We have studied the behaviour of the polyethylene (PE) market in China for the past ten years,” said the first of the companies we interviewed, who was referring to reports we have received that this a peak demand season in China.
“Business has slowed down from mid-November onwards until January over the last decade.
“True, this is an agricultural film season that will provide some support for low-density PE (LDPE) and LLDPE demand.
“But I don’t hold with the argument that there is already strong demand in China for packaging material ahead of the Chinese New Year (CNY). CNY isn’t that big a deal anyway for PE.” (He was again referring to comments made by traders to the blog).
“This is definitely a quiet season overall as everyone is trying to minimise the stocks on their books for tax and financial reporting reasons. We are well past the peak manufacturing season in China for making finished goods to be exported to the West in time for Christmas.
“What we think is instead happening is that there is a lot of trader talk to justify higher prices.
“The traders are moving PE to China to take advantage of the potential for a stronger Yuan as the dollar weakens on quantitative easing.
“Traders sell material in China to obtain Yuan that they then place into a deposit account – carrying interest rates of 2.5% which is much higher than you get in many other places – and wait for the local currency to strengthen.
“And so we believe that the demand we are seeing is not driven by fundamentals, but it is instead about speculation and we are worried about inventory levels.
.”We are concerned about a sudden correction in commodities in general as all the clever investors profit-take and get out.”
The source with the MEG producer told us that his company was also worried about recent price hikes.
“Three months ago inventory levels in China were at an all-time high at a near maximum level of 600,000 tonnes,” he said.
“They have come down a bit recently to around 500,000 tonnes, but prices still rose late last week in line with equities and in response to what was happening in crude – and also on the purified terephthalic acid (PTA) and cotton futures exchanges.
“There are supply reasons why MEG has been so strong this year – i.e. the great supply surge hasn’t happened this year because of problems with running new plants.
“But we still do not understand why prices went up last week given these still-high inventory levels.”
As for what this will all mean for demand growth in China next year, perhaps the most telling and worrying comment in all the recent news reports came from Arthur Kroeber of Beijing-based economic research company, Dragonomics.
“The (Chinese) government’s top priority has now switched from guaranteeing growth to controlling rising prices,” he was quoted as saying in yesterday’s Financial Times.
Are we moving from huge stimulus to de-stimulus and what will this mean for the chemicals industry?