China Commodity Outlook Brightens

Lost amid the headlines about China's decision to end its one-child policy was news that points to a brighter medium-term outlook for commodity demand in the world's biggest consumer of natural resources.

While all the nitty-gritty details of the ruling Communist Party's fifth plenary have yet to be published, the world of commodities should note the commitment to double gross domestic product (GDP) and per capita income by 2020 from 2010 levels.

This should go some way towards alleviating fears that China's economy is in structural decline, as achieving those goals will require ongoing urbanisation to boost earnings to a level where China could be considered a middle income country.

While it's no secret that Chinese leaders want to see an economy led by more sustainable consumer spending, in order to get there the country needs consumers with higher disposable incomes, and this means city-based jobs, whether these be in services such as finance or in manufacturing.

China's per capita GDP is currently around $6,000, or less than a sixth of the $50,600 a person in the United States. A more valid comparison would be to a country like Malaysia, which has a per capita GDP of about $10,500.

Achieving per capita GDP similar to Malaysia would allow China to become more consumer-led, while still enjoying a large export-focused manufacturing base.

The key question is how Beijing will go about its aim of getting per capita GDP to something closer to $10,000 in the next five years.

It's hard to see any way to achieve such levels of economic growth without a large programme of infrastructure and housing construction.

This makes it all the more likely spending taps will be fully opened in the next few months, with a consequent boost to demand for industrial commodities such as steel and copper.

But, as usual, there are caveats in this positive scenario for commodity demand in China.

OVER-CAPACITY, OVER-SUPPLY REMAIN
The first is that even an acceleration in demand for infrastructure and construction may not be enough to soak up the supply overhang of many commodities.

The Chinese steel sector has at least 200 million tonnes of unused annual capacity, possibly more, and weak domestic demand has resulted in mills trying to export surplus production. Outbound shipments of steel have thus jumped 27.2 percent in the year through September from the same period last year.

It's a similar story for aluminium, with China's smelters increasing exports by 17.7 percent in the first nine months of the year compared to the same period in 2014.

This means that even if domestic Chinese consumption picks up, it may not be immediately apparent in demand for imports of raw materials such as iron ore and coking coal.

Import demand for these commodities should at least stabilise, however, and may start to show stronger growth over the course of 2016.

Iron ore imports were flat in the first 9 months of 2015, while unwrought copper imports were down 5.5 percent - although copper ores and concentrates gained 9.3 percent as China increased its own smelting capacity.

Coal remains unloved, with imports dropping nearly 30 percent in the first nine months of the year. The decline, though, is mainly driven by policy changes aimed at curbing use of the polluting fuel in coal-fired power stations.

The other caveat is that even if demand does pick up for commodity imports, it may not be accompanied by a rally in prices. Many commodities still remain in structural oversupply following the overbuilding of capacity by resource companies in the past decade.

Iron ore and coal are perhaps the most obvious examples, but they are about to be joined by liquefied natural gas (LNGLF). The crude oil glut also looks set to hang around for the rest of the year and most likely for most of 2016.

While it may not herald a resurgence of the boom years, the fifth plenary should challenge the view of many in the market that China's commodity story is largely history.

It may not be as spectacular as in the past decade, but a more mature and steady China looks as if it will do its part to rescue commodity producers from the folly of overbuilding.

By Clyde Russell