China Bites Into Commodities Reserves

By CAROLYN CUI

China appears to be eating into some of its commodities reserves, a potentially worrying near-term trend for commodities producers and investors, analysts said.

The phenomenon could help explain why imports from China in markets such as refined copper, iron ore and lead have declined in the last few months. It also could be a factor behind the recent drop in prices for those commodities.

Access thousands of business sources not available on the free web. Learn More

The Dow Jones-UBS Commodity Index last week dropped to its lowest level since July, before recouping some of its losses. The index is down 9.9% this year.

In April, China posted a significant drop in imports for some commodities, leaving many analysts wondering whether China's appetite for commodities has abated.

That might be the case. And demand could falter if China further tightens monetary policies to slow growth, particularly in heated property markets.

But several analysts who through field visits and data mining try to gauge China's actual demand lately have concluded that domestic demand still is strong. In fact, they surmise, commodity imports are declining at least partly because the country and its industrial companies are tapping reserves, possibly because they expect prices to fall further.

Longer term, the Chinese government and industrial companies there are likely to return to the market when reserves are running down or prices get low enough, the analysts said.
[abreast] Color China Photos/Zuma Press

Some are concerned that manufacturers are responding to fewer orders from customers, preferring to use the materials they already have rather than add to their commodities stocks. Others said Chinese commodities users are being savvy, waiting for market prices to decline further before stepping up buying. Above, a worker walks on the steel pipes at an iron and steel factory in Huaibei in central China's Anhui province.

Short term, a move to tap reserves is a potentially bearish signal for investors in these commodities, as China's reserves are deep. Analysts at Deutsche Bank said the third quarter may see "considerable pressure" for prices on commodities such as copper and nickel.

Barclays Capital metals analyst Natalya Naqvi wrote last week that China's decline in lead imports may "reflect some running down of domestic stocks." She estimated that China has been eating into its lead stockpiles since March.

China consumes about 40% of the world's lead, which is used primarily in making auto batteries. Since mid-April, prices for lead plunged as much as 26%, compared with an 11% decline in the Dow Jones-UBS Commodity Index.

Still, her note said "macroeconomic data and auto sales in particular have been strong," and that Barclays expects China to turn into a net importer of lead again "towards the end of the year," giving prices room to rise. Aluminum and zinc probably also showed a drawdown in stocks recently, Barclays concluded.

China imported record levels of copper in 2009. In April, the International Copper Study Group cited "the potential release" of inventories in China as one of the biggest risks copper prices face this year. That month, China's refined copper imports declined 2.7% from a year earlier, according to the country's General Administration of Customs. "They had imported much more than they could use last year, so they may be" tapping inventories this year, said Ana Rebelo, chief statistician of the group.
[ABREAST]

After a field trip to China in mid-May, analysts at Macquarie Securities said some end users of steel, such as auto makers and home-appliance producers, are "choosing to eat into their own inventory, rather than continue to purchase" on the open market.

It is a typical "buyers' strike" when prices are falling, the analysts wrote. "Why buy steel today when it'll be cheaper tomorrow?"

Confidence that prices may fall further could be behind the Chinese reluctance to buy. Since late April, the benchmark hot-rolled flat steel price has fallen as much as 10%, to $600 a metric ton in China, according to the Steel Business Briefing, a firm that tracks steel data. Prices for iron ore, a key component of steel, dropped 23% in that period.

The Macquarie analysts concluded that underlying demand for cars and refrigerators in China remains robust and that manufacturers soon will stop draining their own stockpiles and return to the market.

"While we expect further weakness in the near term, we didn't hear anything that fundamentally changes our view on China steel," they wrote. "We expect conditions to turn around fairly rapidly." Macquarie estimated China's steel inventory peaked in January, and has since dropped about 15%.

Lower steel prices eventually will result in production cuts at mills and help balance the market, they said. The bank estimated steel demand will recover in the fourth quarter.

China still appears to be an avid buyer in some markets, particularly coal and crude oil. In April, China reported that its crude-oil imports jumped 31%, to 5.2 million barrels a day.

Paul Ting, president of Paul Ting Energy Vision, an oil-consultancy firm, estimated Chinese oil demand expanded 13% during the first four months, suggesting there was a small build in oil inventories.

Write to Carolyn Cui at carolyn.cui@wsj.com