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Standard and Poor's raises the spectre of big falls in commodity prices should China's economy slow significantly

Standard and Poor's raises the spectre of big falls in commodity prices should China's economy slow significantly

International credit rating agency Standard & Poor's (S&P) is warning record high commodity prices may represent an unsustainable bubble, subject to a sudden correction, especially if the Chinese economy is hit by a significant deceleration or downturn.

In a 22-page report entitled The Potential Risk of China's Large and Growing Presence in Commodities Markets, S&P also suggests that of China's total banking system assets, up to 40% are potential "problematic assets."

The report suggests it would be difficult to overstate the significance of China's presence in the global commodities markets and looks at the specific examples of copper, aluminum, steel, coking coal, iron ore, crude oil and soybeans, the only agricultural commodity specifically covered in the report. New Zealand has seen the prices of its key agricultural commodities rise strongly in recent months with the ANZ Commodity Price Index rising for nine consecutive months.

"We believe that any sudden and severe economic deceleration in China would cause distress in the commodities markets, forcing prices downward and leaving companies with excess supply and production capacity that the more-developed economies couldn't pick up," S&P says.

"With commodities prices having been at or near record levels earlier this year, and subsequently subsiding only modestly, Standard & Poor's Ratings Services is naturally concerned that the current situation represents an unsustainable bubble, subject to a sudden correction."

'Bubbles inevitably burst'

The credit ratings agency further notes that market bubbles inevitably burst, but are much easier to recognize with the benefit of hindsight.

"Among emerging economies, we believe China, given the combination of the size of its economy and the steep slope of its growth trajectory, has had a far more significant role in driving appreciation of commodities prices than any other country."

Possible reasons for a significant downturn in China include governmental economic policy missteps, bank system asset quality problems, and external shocks such as a global double-dip recession, a rise in protectionism, or second-round effects from a geopolitical event, says S&P. It says the specific impacts of a severe slowdown in China would depend on what caused it, including whether the causes were mainly internal or external.

S&P also points out that each commodity has its own market dynamics and industry structure, meaning the emergence of China has played out variously in each.

In the report S&P notes that;

*China's share of total world copper consumption has risen dramatically, reaching 39% in 2010, from about 22% in 2005, and China is now the world's largest copper-consuming country.

*It estimates China's primary aluminium consumption was 16.8 [million] metric tons in 2010, over taking the US to become the leading consumer, and accounting for about 43% of global primary aluminum consumption compared with only about 13% in 2000.

*China is now the world's largest steel consumer, accounting for about 42% of global consumption in 2010.

*China therefore accounts for a disproportionate share of world iron ore and coking coal demand, at 60% and 52% of world consumption, respectively, in 2010.

*Last year China was the world's second-largest oil consumer, accounting for about 10% of world demand, behind only the US, which accounted for 22%.

*China's share of global soybean imports has jumped to an estimated 58% for the 2009-2010 crop year from about 25% in the 2000-2001 crop year.

Big falls likely in 'severe' downturn

The credit rating agency suggests that in a severe downturn the following falls in market prices (all prices in US dollars) are possible:

Aluminum: $0.65-$0.70/lb, compared with about $1.20 presently.

Copper: $1.50-$1.75/lb, compared with about $4.10 presently.

Iron ore: $85-$95/ton, compared with about $170-$175 presently.

Coking coal (seaborne at mine): $100-$120/ton, compared with about $180 presently.

Steel, hot rolled coil: $475-$525/ton, compared with about $750-$760 presently.

S&P says it's harder to pick the likely floor for the crude oil price in a downturn because OPEC adjusts production levels to manage prices and a significant amount of world capacity is controlled by state-run oil companies.

"During the recession of 2008-2009, world consumption of crude oil declined by about 1.5 million barrels per day (or 1.8%), in spite of China's consumption growth of about 1 million barrels per day. In the course of the downturn, prices declined from a high of $134/barrel (West Texas Intermediate, monthly average) in June 2008, to a low of $39/barrel in February 2009. (That's a $95, or 71%, drop). We would not rule out the possibility that prices could fall to such lows again, in the event of a severe slowdown in China accompanied by downturns in the major developed economies," says S&P.

It also suggests that soybean prices could fall to less than $10 a bushel from current spot prices of about $13.5/bushel in the absence of Chinese imports.

'Credit quality of commodities producers would come under threat'

'Though such severely depressed pricing is only hypothetical, if it occurred, we would expect the credit quality of commodities producers to again come under pressure, as during the past recession," S&P says. "The most vulnerable companies would naturally be those that are already lower-rated due to such factors as lack of product diversification plus high financial leverage."

S&P says it does expect China's economy to sustain high growth rates over the next few years, although possibly not quite as high as in the recent past. China's Gross Domestic Product rose 10.3% last year.

Meanwhile, S&P also says the Chinese banking system poses risks, due to "relatively lax underwriting standards" at some banks.

"As a result of various stimulus programs, 2009 alone saw a 33% increase in domestic credit, with a significant amount of borrowing concentrated in companies owned by local governments," S&P says.

"Many of these public enterprises have weak financial profiles and undertook projects that have not been profitable. We see some risk that a sharp increase in nonperforming loans, brought on by an unexpectedly abrupt economic slowdown or other shocks, could damage bank balance sheets in China." See interest.co.nz's recent interview with Ryan Tsang, S&P's Hong Kong-based banking analyst, here.

Overall S&P puts China's potential gross problematic assets in the range of 25%-40% of total banking system assets.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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30 Comments

"*China's share of total world copper consumption has risen dramatically, reaching 39% in 2010, from about 22% in 2005, and China is now the world's largest copper-consuming country."

*It estimates China's primary aluminium consumption was 16.8 [million] metric tons in 2010, over taking the US to become the leading consumer, and accounting for about 43% of global primary aluminum consumption compared with only about 13% in 2000.

*China is now the world's largest steel consumer, accounting for about 42% of global consumption in 2010.

*China therefore accounts for a disproportionate share of world iron ore and coking coal demand, at 60% and 52% of world consumption, respectively, in 2010.

*Last year China was the world's second-largest oil consumer, accounting for about 10% of world demand, behind only the US, which accounted for 22%.

*China's share of global soybean imports has jumped to an estimated 58% for the 2009-2010 crop year from about 25% in the 2000-2001 crop year."

Its growing at 10% per annum so double every 7 years.....looks about right........so say it doesnt catch a cold....just where does it get its raw materials from in just 6 or 7 years? it will take 80% of the copper production....86% of aliminium, 84% of steel.....iron ore  120% , coking coal 104%, 20% of oil and be matching the US.....116% of soya beans....

So it cant continue at 10% it has to stop inside of 7 years....

regards

What is the US doing with all that oil?  22% of world supply - and the next largest consumer (China) is using less than half that at 10%.

I'd love to see a breakdown between US consumer use and US military use.

 

 

A lot of oil goes into fuel....americans drive gas guzzlers....they probably use at least twice as much as anybody else to get around...

regards

Yanks won't walk a step outside of a shopping mall. And petrol is still very cheap there no matter how much they bleat. Oh and yanks are greedy fat pigs who believe GAAAAAAAAAAAD created the world outside the USA for their personal consumption. LOL!

Well Steven, up 'til relatively recently not only were the U.S. the biggest consumers of petroleum, but also the biggest sellers. Even during the Oil Crisis of the seventies, U.S. oil companies still owned the majorty stake in Saudi Arabia's oil deposits. The Saudis were only allowed to nationalize the oil infrastructure in the late '70s only once they'd agreed to invest their income in U.S. Treasuries.

The American lifestyle was essentially designed to ensure that they consumed as much energy possible so that the supply of energy was scarce enough to protect the profitability of U.S. oil investments. Their attitude can be summed up by the statement below.

In January 1948, James Forrestal, recently appointed as the country’s first Secretary of Defense under the new National Security Act, discussed with Brewster Jennings, President of Socony-Vacuum (later renamed Mobil Oil), how "unless we had access to Middle East oil, American motorcar companies would have to design a four-cylinder motorcar sometime within the next five years."47

http://cmes.hmdc.harvard.edu/files/Mitchell%20Paper.pdf

The agenda of the United States since World War II is best epitomized by a memo written by George F. Kennan, who was the author of the US's containment policy against the Soviet Union.

Furthermore, we have about 50% of the world's wealth but only 6.3% of its population. This disparity is particularly great as between ourselves and the peoples of Asia. In this situation, we cannot fail to be the object of envy and resentment. Our real task in the coming period is to devise a pattern of relationships which will permit us to maintain this position of disparity without positive detriment to our national security. To do so, we will have to dispense with all sentimentality and day-dreaming; and our attention will have to be concentrated everywhere on our immediate national objectives. We need not deceive ourselves that we can afford today the luxury of altruism and world-benefaction. 

http://en.wikisource.org/wiki/Memo_PPS23_by_George_Kennan 

"In January 1948, James Forrestal...."

I guess it depends on how you read the para....

Doesnt read that way to me....

"George F. Kennan"....interestingly, he was a bit of a critic of the US administration later on...

"..........the basic demographic problem involved in the relationship between their food supply and their birth rate."

Interesting piece....I could get to like this guy he shows he can think.....

The biggest thing for me though is getting a feeling of the entire piece to get the context of the one paragraph you have pasted.....my reading is you could take that one paragraph out of context unless you read all of the piece.

I feel you are...

regards

 

if I was to take this as read....if they can't control the resources economically... war will result at some point, prices can only go so high before countries aspire to take it off you.

i made a booboo

ddd

Exactly steven .. and while your at it throw in  USD 1 000 000 000.00 that came hot off the printing  presses from QE1 + QE2 , the structural supply side imbalances that wont get  addressed for at least another 5-10 years  and you start to wonder just whether these guys are getting their crack from a reputable source.

Also its amusing to hear  the NZD is too high. Rubbish! How is it we can have a record trade surplus. It is a Weak USD , EURO , GBP etc story. The NZD is relatively weak against AUD .Also  suppressing our currency is very negative for inflation and if you’re a fan of  James Grant that should  concern one as it does me.  Also it  penalises the savers and rewards yet again those that are highly leveraged. This is a great site but the research needs to be more objective.    

Love James Grant...he's refreshing....I mostly agree with him...he's hard to argue against...he knows so much.....

NZD v the rest, exactly....its relative....Hugh Hendry summed it up well when he said he would be a giant amongst dwarfs...ie everyone else was taking more risks and if those risks eventuated they would be devistated....there are times when you protect your wealth and minimise losses.....this is one of them....Bollard and our Govn is doing the same thing looking after NZ while everyone else races for the bottom....

regards

I agree the US is trying to inflate it's way out of the problem by printing money and reducing the value of the yanky. Does this mean the Dow hasn't really gone up much in real terms? Over the last couple of years.

Its good to correct against inflation....but for me its the insane price to earnings ratios they seem to believe is OK....it comes down to the only gain off shares is their increase in value which is obvioulsy risky.

For me what ever its done its to risky, I bailed a year ago....the market hasnt really done much so Ive lost little....in fact I think im ahead slightly...im not stepping in and buying shares until the massive correction I expect has occured....

regards

Kate, they are trying to create growth its all they know.Interstate 5 was full last friday huge numbers of vehicles and trucks. Memorial day was Monday, so it was a busy day, still an impressive display of resource use without a care for the future. 

 

Take the I5 through greater LA, potentially 20 million people can feed onto this interstate to get through the urban sprawl...thats some momentum to turn around... to think that is just one freeway through one international city.

Much of this would apply to countries with mineral exports like Australia.

What they could have said is there is a rapidly growing middle class in the likes of China, India, and in Asia generallly which creates a sustainable demand for agricultural products, which is applicable to NZ.

Yep they want meat and wil pay for the quality...

regards

Hey I'm ready...just waiting for the bubble to implode...they say 80% of the trades in the US are computer generated and fed funded...the whole stinking corruption will blow...

Then when the blood is all over the street...time to buy the good stuff, put it in the drawer and retire to the boozer to await the other side of the depression.

Reading this, I reckon you are already in depression.

but I think Wolly is right.....

regards

http://www.nzherald.co.nz/opinion/news/article.cfm?c_id=466&objectid=107...

While I wouldnt dive into [food] commodities today or farms I kind of feel this is an area to keep and eye on....

regards

William Gross ( PIMCO founder ) described credit rating agencies as " an idiot savant with a full command of the mathematics , but with no idea how to apply them . "

S & P were one of the CRA's who continued to mislead investors by giving ENRON a AAA credit rating , just 4 days before the company collapsed . The greatest bankruptcy in US corporate history at the time .

S & P never gave the US a credit downgrade, not one , during the presidency of George W. Bush , despite the invasion of Iraq , and despite the huge personal income tax cuts . Both situations greatly magnified the overall US debt load .

S & P gave a AAA rating to collateralized debt obligations ( CDO's ) issued by Credit Suisse Group , which subsequently lost 63 % of their value .

Mc Graw-Hill , owner of S & P , approached financial writer Barry Ritholtz to author a book on the unfolding global financial crisis . When they saw that he was critical of the role of  the CRA's , including their subsidiary S & P , they dumped publishing of the book . Ritholtz fumed " I'm so pissed off at these doofuses ........... I really thought they wouldn't be jerks ".

S & P signed off tens of thousands of CDO's and RMBS's ( residential mortgage backed securities ) during the mid 2000's , as AAA rated investments , when in actuality they were junk issuances . Investors trusted the high ratings given by S & P to these risky invesments , and the rapacious real estate speculation continued unchecked .

Preceding the GFC , S & P contiued to give AAA ratings to all tranches of debt issued by US " too-big-to-fail " trading banks and investment banks ........... But now , in 2011 , they're lowering the boom on Chinese banks , the guys who didn't underwrite subprime loans , the banks who didn't loads up on toxic debts and credit default swaps .

Bill Gross was right . We're all well advised to totally ignore the utterances of the credit rating agencies .

GBH, it is interesting to note that the first rating that the new chinese agency delivered was to lower the US debt  rating... that was one year ago.

Yes but how much of it is political? answer just about all of it I suspect....so they maybe right but I'd say for the wrong reason.

Is the US is a bad way? when you look at Europe and its very probable ad maybe imminent  implosion it doesnt look so bad....if the EU breaks up will that effect the US ? yes and teh world....but where can you hide?

regards

BTW, if copper was to fall to 150 c then JP Morgan would be is serious trouble because they have been handing China loads of credit against the colleteral of fisical Copper, so eventualy the Chinese could tell JP Morgan to keep the Copper... thank you. It is a perfect hedge against any drop in the price of the asset.

Peter Schiff for all those who like US financial facts

 

 

www.youtube.com:watch%3Fv=wRFP3z0FCK4

 

Good luck all

This is Peter Schiff's radio program, really good peice about Greenspans interveiw the other night on Squak Box in the latest one, also some interesting stuff about GM.

 

http://www.schiffradio.com/site

 

You have to actually download the mpeg (can't stream it unless your a paying member) and then listen thru your media player. Worth the effort tho.

yeah right.....

Complete with lots of gold adverts?

regards

Actually Steven he actually came out and hammered Goldline (a big company in the US) for trying to rip people off by hard-selling overpriced commerative coins. Infact on one of the 2 episodes availible he reiterates to a caller that if he or anyone is to buy physical gold, they need to shop around and steer clear of commerative coins.

 

And by the way the episodes are ad free.

 

Apart from in one of them there is an editing error and it plays a few seconds of a Viagra ad  :)

Steven why don't you just give it a listen before you knock it.

If you don't like it don't listen to it again.

A warning tho he is about as idologically opposite to you as they get. He's a free market guy.

 

 

In order to make the above projections for each raw material wouldn't you have to look at global physical production and growth as opposed to basing conclusions on % consumption pattern changes for China? Wouldn't you also have to factor in technical change in use, current stock positions, recycling, new deposit discoveries, and the effect of substitution as prices rise? The conclusions might be the same or similar - can't say without the numbers.

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Days to the General Election: 35
See Party Policies here. Party Lists here.