Bloomberg: China Soft Landing May Be Hard for Commodity Exporters

Bloomberg

China Soft Landing May Be Hard for Commodity Exporters
By Bloomberg News - 2012.03.26 10:41 AM

The good news: China’s government will engineer a soft landing. The bad news: Even a soft landing is painful for industries that have become dependent on the world’s fastest-growing major economy as their main profit engine.

Analysts at Deutsche Bank AG, Nomura Holdings Inc. and Daiwa Capital Markets raised forecasts this month for 2012 expansion to as high as 8.6 percent, partly on anticipation of looser monetary policy. The projections, still below last year’s 9.2 percent rate, offer little comfort for Australian mining company BHP Billiton Ltd. (BHP), seeing slower steel production in China, or German automaker Daimler AG (DAI), whose Mercedes dealers in the nation are giving record discounts.

“China’s still going to be growing reasonably strongly,” said Nicholas Lardy, senior fellow at the Peterson Institute for International Economics in Washington and author of the 2012 book “Sustaining China’s Economic Growth after the Global Financial Crisis.” Even so, “the super commodity cycle that was driven by China is moderating, and exporters that have ridden the property boom over the last four or five years face a much tougher time.”

Premier Wen Jiabao’s curbs on property sales and his plan to tilt the economy toward consumption and away from a dependence on capital spending have reduced production of steel and cement and helped push iron-ore prices down more than 20 percent from last year’s high. At the same time, policy makers are ready to take any action necessary to avert a steep deceleration in a year when the ruling Communist Party desires a stable leadership transition, said Tim Condon of ING Financial Markets.

‘One-Way Bet’

“The idea that commodities are just a one-way bet as an asset class is over,” said Condon, ING’s Singapore-based head of Asia research, who previously worked at the World Bank. “My baseline view is that China will still do whatever it takes to keep growth going. It if slows too much, they will stimulate.”

Copper fell to a two-week low in New York March 22 after a preliminary purchasing managers’ index for China from HSBC Holdings Plc and Markit Economics dropped to 48.1 from a final 49.6 in February. Readings below 50 signal contraction. Nickel and lead also erased gains for the year. China is the world’s largest user of copper.

BHP Billiton, based in Melbourne, Australia, and Glencore International Plc (GLEN), a Baar, Switzerland-based supplier of commodities and raw materials, already have been roiled by the slowest expansion rate in China since the global recession ended in 2009, with shares of both down more than 20 percent from a year ago.

Weaken Currencies

Concerns about China and its property market probably will weaken Australia’s and Brazil’s currencies, according to Stephen Jen, managing partner at SLJ Macro Partners LLP in London. The Australian dollar, which traded at $1.0467 March 23 against the U.S. dollar, may test parity within the next few weeks, while Brazil’s real may drop to as low as 2.50 per U.S. dollar, a level not seen since 2008, he predicted. It traded at 1.8102 March 23.

While the yuan was fixed today at 6.2858, a record high against the dollar, the currency has been little changed this year amid slowing export growth, after a gain of 4.7 percent in 2011. Pressure for appreciation has declined as China’s current account and trade surpluses have fallen over the past four years, said Louis Kuijs, an economist with the Fung Global Institute in Hong Kong.

China’s government has been trying to reverse a surge in home prices, boost consumption and move away from exports and capital spending without causing a sharp reduction in growth. Wen pared this year’s expansion target to 7.5 percent from an 8 percent goal in place since 2005, he announced March 5 at the legislature’s annual conference.

The Shanghai Composite Index (SHCOMP) slid 2.7 percent in three days on the news. U.S. and European stocks fell March 20 on concerns about China after the country raised fuel prices by the most in two years and BHP Billiton said China’s steel-output growth has flattened.

Increasing U.S. Momentum

Any slowdown may be offset by increasing momentum in the U.S., still more than double the size of China’s economy. The Labor Department recently reported the best six-month streak of job growth since 2006, sales of previously owned homes held in February near an almost two-year high and the Federal Reserve has said it will keep its benchmark interest rate near zero until at least late 2014.

Debate over China’s economic direction may take center stage next week at the Boao Forum for Asia, a three-day conference for business and political leaders modeled on the World Economic Forum in Davos, Switzerland, and held on China’s southern resort island of Hainan. More than 150 officials and executives are scheduled to attend, including Vice Premier Li Keqiang, PepsiCo Inc. Chairman Indra Nooyi and World Bank President Robert Zoellick.

Agricultural Benefit

Some resources may get a boost from Wen’s efforts to shift the economy toward consumer spending. So-called soft commodities that are grown, including corn and wheat, “may in fact benefit from dietary changes and upgrades, boding well for agricultural- related sectors,” said Jenny Tian, a managing partner at Springs Capital Ltd., which oversees about $700 million in Hong Kong.

Tian owns Chinese animal-feed companies including Guangdong Haid Group Co. (002311), based in Guangzhou, and Beijing Dabeinong Technology Group Co., while avoiding construction machinery and so-called hard commodities, such as metals, that are mined or extracted, she said.

These industries are suffering from slower capital spending and curbs on the property market, which accounts for more than one-fourth of final domestic demand, according to UBS AG. Higher down payments and restrictions on mortgage interest rates and housing purchases in 40 cities contributed to home prices in February posting the worst performance in a year, and sales falling 25 percent in the first two months of 2012.

Could Cause ‘Chaos’

Wen on March 14 indicated no imminent relaxation of the cooling measures, saying home prices remain far from a reasonable level and easing curbs could cause “chaos” in the market.

Investment in roads and other infrastructure may decline 25 percent in China’s five-year plan through 2015 when adjusted for inflation, and home ownership, at 67 percent, already is above the global average, said Tao Dong, chief regional economist at Credit Suisse AG in Hong Kong. The “golden age” of China’s boom in these economic segments is over, he said.

China’s leaders, while guiding the economy to a soft landing, have monetary, fiscal and regulatory ammunition to shore up growth as they deem necessary.

Inflation that touched a 20-month low of 3.2 percent in February will allow policy makers to “ramp up money supply and stimulate the economy if they need to,” said Mark Mobius, Hong Kong-based executive chairman of the Templeton Emerging Markets Group, which manages $50 billion in assets.

Large Scope

Policy makers, in theory, have large scope for lowering big banks’ reserve requirements from the current level of 20.5 percent of deposits, People’s Bank of China Governor Zhou Xiaochuan said March 12, comparing it with a 6 percent ratio as recently as 2003. They’ve also kept a benchmark interest rate at 6.56 percent, even as central banks in Europe, Brazil and Australia have cut borrowing costs.

The government will ease its property curbs as early as midyear, predicts Fred Hu, chairman of Primavera Capital, a Beijing-based private-equity firm he founded.

“It’s not a question of whether, it’s a question of how soon” policy makers will act to support local-government income from land sales and migrant construction workers’ jobs, said Hu, former chairman of Greater China for Goldman Sachs Group Inc.

Wen’s 7.5 percent national growth target may prove to have little resemblance to the final result, as regional governments are aiming higher. The southwestern province of Guizhou has a goal of 14 percent; central Shaanxi province, 13 percent; and Chongqing, China’s wartime capital on the Yangtze River, 13.5 percent.

‘Backward Areas’

“For backward areas, 7.5 percent is not enough,” said Liu Gang, Communist Party secretary for the city of Heihe bordering Russia in Heilongjiang, which envisages growth of 12 percent.

The country’s fiscal position is “very strong,” with foreign-exchange reserves of more than $3 trillion, Mobius said. “They have a high savings rate, debt levels are low and that means they are in pretty good shape.”

The news is less sanguine for nations and companies focused on commodities, with Jen predicting Australia and Brazil in particular will feel the impact of “the hit to commodity imports, particularly iron ore and building materials.” Shares of London-based Rio Tinto Group (RIO), the world’s third-largest mining company, have dropped 16 percent in London to 3,382.5 pence from a Feb. 2 high this year. Rio de Janeiro-based Vale SA, Brazil’s biggest exporter, has slumped 15 percent to $22.85 from a Feb. 3 high.

Mexico’s peso slipped on March 22 to the weakest level against the U.S. dollar in two weeks after manufacturing slowed in China.

Longest Losing Streak

Stocks of developing countries extended their longest losing streak this year on the news. The MSCI Emerging Markets Index (MXEF) fell 0.7 percent on March 22 to 1,040.58 in New York, slipping for a sixth day. Energy and materials companies retreated the most, with Russia’s OAO Gazprom, the world’s largest natural-gas exporter, sliding 2.2 percent.

The MSCI index today was little changed at 1,041.15 at 10:49 a.m. in Tokyo.

“China is definitely slowing down,” said Andy Mantel, founder and chief executive officer of Pacific Sun Advisors, an asset manager in Hong Kong. “Over the course of a few months, the numbers will be quite weak.” Mantel said he’s optimistic China nevertheless will avoid a hard landing. “People’s expectations are too high, and you have to allow China to grow as it can.”

--Kevin Hamlin. With assistance from Li Yanping, Stephen Engle and Michael Forsythe in Beijing. Editors: Scott Lanman, Melinda Grenier.

To contact the reporter on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net