Monday, May 21, 2012

Commodity price declines point to demand problems in China

A sobering article from Reuters points to potential credit problems with commodity buyers in China. It seems some middlemen have in the past been taking speculative inventory with the goal of earning more than the usual spread. As demand slowed, these buyers are having trouble raising cash to meet their obligations. They typically relied on rapid sales to their customers to purchase new inventory - but that does not seem as easy these days.
Reuters: - Chinese buyers are deferring or have defaulted on coal and iron ore deliveries following a drop in prices, traders said, providing more evidence that a slowdown in the world's second-largest economy is hitting its appetite for commodities.

China is the world's biggest consumer of iron ore, coal and other base metals, but recent data has shown the economy cooling more quickly than expected, with industrial output growth slowing sharply in April and fixed asset investment, a key driver of the economy, hitting its lowest in nearly a decade.

Coal and iron ore prices could fall further before recovering towards the tail end of the second quarter, traders say, sparking more defaults or deferred deliveries.

"There are a few distressed cargoes but no one is gung-ho enough to take them. Chinese utilities aren't buying because they have a lot of coal and traders are also afraid of getting burnt. It's very bearish now," said a trader.

The defaults come on the heels of a slump in global thermal coal benchmark prices to two-year lows and increases the prospect of an even steeper fall unless China revives buying to absorb the global coal surplus as exporters ramp up production.
Anecdotal evidence also suggests that wholesalers are cutting coal inventories in a number of ports. Spot prices for coking coal have indeed been dropping.

China Foundry Coke Domestic Spot Price Shanghai (Bloomberg)

These events may be an indication of a demand slowdown in China that is far sharper than anticipated - driven primarily by reduced infrastructure investment (discussed here). A more aggressive stimulus program from the government may be on the way shortly.

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