International | Aug 15 2006
By Chris Shaw
All the evidence points to a slowing in the US economy, but if we assume that is the case the question for those following the resources cycle (or those long resource shares) is will such a slowdown flow through into China and signal an end to the commodity boom?
According to HSBC the answer is no, at least not if the US economy experiences a soft landing rather than a hard landing. While accepting a hard landing would more than likely flow through into a significant slowdown in the Chinese economy, the bank suggests a soft landing in the US is unlikely to cause too much damage to either China’s growth rate or the commodity story given the current rate of usage of commodities in China is still quite low in world terms.
While the gap has been closing there remains a long way to go before China is using the same level of commodities per head of population as the rest of the world, not least because the industrialisation of the economy as a whole is a process that will take some time.
The bank also notes the commodity usage figures in China show coal is the most heavily used source of energy, in large part because it remains the commodity of which China has the greatest supply. Over time such an imbalance is unlikely to continue though, so demand for oil and gas will potentially grow even faster than demand for coal, which has positive implications for overall commodity demand.
Official figures support such an outlook, as Energy Information Administration (EIA) figures show China’s demand for energy will rise by a little over 200% between 2003 and 2030, against an increase of 71.5% for the world as a whole. At the same time resource consultancy group CRU estimates a significant increase in Chinese demand for most major metals between now and 2010. It expects the rate of increase will be well in excess of demand growth globally, which again supports a continuation of the commodity story thanks to ongoing strength of Chinese demand.
Supporting the positive demand picture are a number of other factors, including the current trend towards car ownership in China and the need to upgrade rail infrastructure to deal with the industrialisation of the economy. As HSBC points out, the rise in car ownership is on a par with the rates at which ownership increased in other countries as they industrialised, which implies a sustained period of strong demand for the metals and materials used in constructing the automobiles being bought.
At the same time both passenger and freight numbers travelling via rail are continuing to grow strongly, resulting in an increase in bottlenecks due to infrastructure restrictions. As these bottlenecks are constraining overall economic growth additional construction is expected, the bank noting there are plans in place for a further 6,000 miles of track to be added by 2010 and 60,000 miles by 2020.
Such a level of activity will be a boost for iron ore, coal and the other materials required in the construction process, but as importantly will help open up much of the country to the rest of the world, which again should result in stronger demand for commodities generally.
Finally, the bank notes despite the fears of housing bubbles as construction booms in cities such as Shanghai the overall housing market in China remains tight. It points out spending on residential construction is forecast to grow by between 9-13% between now and the end of the decade, which again means strong demand for construction materials.
The conclusion the bank draws is this – the likelihood is China will continue to have a significant impact on demand for commodities going forward, as the basic needs of its society suggest demand will continue to increase from current levels. The spanner in the works remains the US economy, but with interest rates at a level providing scope for cuts if there is a need to spur growth, a hard landing should be avoidable.
As a result, HSBC suggests commodity markets remain reasonably cheap, even if conservative price forecasts are used for valuation. While the bank lists Brazil and Russia as its top markets for exposure to the commodities story, such an outlook for resources should also prove to be favourable for the Australia resources sector.
