By John Richardson
THERE is a very risky theory that I have picked up in my conversations with Asian polyolefin industry players over the past few days:
Strong underlying demand growth in China, low stock levels held by the country’s plastic converters and a stabilisation of oil prices will result in a firm recovery in demand after the Lunar New Year.
(Most of China will, by the way, be on leave from 18 February to 24 February).
Let’s first of all tackle the “strong underlying demand growth” argument.
Everyone keeps on saying that China’s demand in volume terms is far bigger than it was a decade ago. Growth of, say, 3-4% in 2015 will thus be from a much-bigger consumption base than ten years ago.
In the Old Normal world this is kind of analysis was, more or less, all that you needed. But we are no longer in the Old Normal world.
China is taking shock medicine designed to revive a very sick patient, or as veteran metals analyst Simon Hunt describes it, “the government knows that they have to clean house”.
Simon, who is UK-based, is in China at the moment. In his interim report on his latest visit he writes the following:
- As a consequence of “cleaning house” there will be bankruptcies of manufacturing, real estate and finance companies.
- “A couple of years ago we spoke about a huge bubble in trade finance or the misuse of Letters of Credit.” The numbers involved could be equivalent of 25% of GDP, he warned.
- He sees the development of the speculation game as taking place in three stages. First, metals smelters started using LCs to speculate in physical and futures markets. Next, they started using LCs to arbitrage interest rates. And finally, companies totally unconnected to commodities, such as real estate and textile companies entered the game. They bought metals just to get their hands on LCs so they could speculate elsewhere. We have seen a similar pattern in PE.
- “What drove the bubble starting from around 2005 was the sense, whether real or not, that the world was as the start of a commodities Supercycle,” he added.
Far too many people believed in this commodities Supercycle, when all the evidence told us that it was based on a unsustainable increase in credit in China.
In response to this mistake,people built or planned too many polyolefins plants, copper plants and steel mills etc.
Speculation in global financial and commodity markets also took place on this mistaken analysis.
This is why I still firmly believe that as credit is withdrawn in China, the global effects will be much bigger than US sub-prime.
We can see this today in metals pricing.
Yesterday, for example, the prices of copper and iron ore fell to five-and-half-year lows.
“For several years after 2000, an apparently relentless rise in Chinese metal consumption raised expectations of a ‘Supercycle’ that would juice up prices indefinitely,” wrote the Wall Street Journal, in the same article to which I have just linked.
“Signs are mounting, though, that Chinese demand is now a less reliable prop for metals prices.”
And where copper and iron ore have gone so, of course, has oil.
“Inventories of US crude were already at record highs for the week ended January 23, according to government data issued on Wednesday. Last week’s build alone was almost 9 million barrels, taking stockpiles to nearly 407 million, the highest level since the government began keeping such records in 1982,” wrote Reuters in this article, which was also published yesterday.
Also see my post from last Friday on crude.
This is what I instead think is going to happen after the LNY:
- The oil price could well fall to new lows and is likely to stay very volatile within a lower range.
- Meanwhile, many processors, distributors and traders will continue to struggle to source credit. I can only see this struggle getting worse as reforms accelerate.
- Local banks will be increasingly reluctant to lend money because of concerns over bankruptcies. The snowball will gather more downhill momentum.
- This means that, regardless of today’s stock levels, polyolefin buying patterns will remain “hand to mouth”.
What goes for polyolefins will obviously also go for many other chemicals and polymers.
This is the beginning of a long and difficult reform process that will be completed. There are surely no doubts about that now.
Only when reforms have finished – and this will take several more years – will we really understand what “underlying demand growth” in China actually amounts to.