Wednesday, July 16, 2008

Commodities in focus: Lead and Zinc producers cut production in China to help slumping prices

With commodity prices heating up around the world, emerging markets have finally began to show signs of slowing demand. The latest metals making headlines are two primary base metals; zinc and lead.

A meeting of 27 major Chinese Lead and Zinc producers took place in Shanghai yesterday. The producers agreed in Shanghai "the move would help improve the supply-demand relation so as to curb further price fall," as reported by the China Mining Association (CMA).

In Chinese yuan, the price of lead ingots has fallen 34% from 26,500 yuan/ton ($3,887 usd) to 16,500 yuan/ton ($2420 usd). Zinc ingots meanwhile have plummeted in price, falling by 53% from 33,360 yuan/ ton ($4,890 usd) to 15,650 yuan/ton ($2300 usd).

China's Nonferrous Metals Industry Association estimates domestic lead consumption shrank 50,000 tons in the period January-May, but stated new projects set to begin in Shaanxi, Hunan, Yunnan and Gansu provinces would help re-invigorate demand.

China has been expanding at such a rapid pace it was almost necessary for a price correction in commodities. Add to the recent trend of investing in commodities as a safe heaven or hedge against other currently more risky investments and you get a situation where commodity prices have risen beyond sustainable levels.

Despite China's robust economic growth and ever increasing demand for raw materials, Chinese demand alone is not enough to keep commodities at their current prices. However, as the largest contributor to global GDP in 2007, Chinese demand is a very important factor.

What to make of all this? A temporary correction in commodity prices at best... and by temporary I do mean a few months or a year at most. Zinc and lead will remain in high demand due to the fact a slowing global economy is not going to bring all projects in China or other emerging markets to a stand still. Second if prices continue to decline, supply will probably remain constrained because some miners will put off exploration or development of new mines due to lower prices which make them economically less viable. This will create a similar situation in the long term when demand recovers and the market realizes there is once again insufficient supply. Economics 101 teaches you when there are too many people chasing the same good, the price of the good will rise, and this will be the case with zinc and lead.

As commodity prices decline, China's miners and smelters may suffer, but government projects and domestic urbanization plans become cheaper. As noted above, prices have declined and new projects are being planned in certain provinces.

The provinces mentioned above are all relatively poor regions in China, lacking infrastructure and in desperate need of investment. Shaanxi is a poor region about 6 hours by bus from Beijing and is at the heart of coal production in China.

Yunnan is a province in South China which boarders Myanmar and is populated by over 20 of China's ethnic minority groups. One of China's strategies for keeping ethnic minorities happy is to ensure the regions where they live experience the benefits of China's economic growth. In recent years Yunnan has also emerged as a popular tourist destination. As the influx of both domestic and foreign tourists increase, so will investments in infrastructure and services.

Gansu is a province in western China and is home to a wide variety natural resources. There is extensive mining in iron, lead, nickel, zinc and other metals. Additionally, two of China's most important oil fields, Yumen and Changqing are located in this region.

Hunan province is located along the Yangtze River and is home to the industrial cities of Changsha, Zhuzhou and Xiangtan. All three cities are major centers of production which account for roughly 40% of the regions economic growth. Currently the three cities are in major need of improvements in their infrastructure and will need to import in the materials necessary to furnish the improvements because of a severe lack in local resources.

If you've been following China's development plan since the 90's, it is clear the central government has chosen a selective development strategy-- focusing on important economic zones and leaving others behind. This is all very important because it shows capacity for growth and development in China remain. This is especially true for the regions described above which until recently have been over-shadowed by the wealthy coastal regions where China's export and manufacturing centers are focused.

The recent earthquake in Sichuan Province, rising disparities between Eastern China and Western China, and the need alleviate pressure on major city centers will prompt Beijing to begin paying more attention to the regions it previously ignored. When this happens, Chinese commodity demand will rise and so will prices.

Zinc and Lead began their bull markets in late 2005 / early 2006. At their respective peaks, both had more than doubled in price in just a few years time-- see LME price charts from 2002 - 2008 below.

London Metals Exchange: Zinc ($US/tonne)

London Metals Exchange: Lead ($US/tonne)

Despite being primary metals used as a economic input in production of goods and services, many industry experts felt the rise in Zinc and Lead prices in late 2005 was uncalled for. The two metals had relatively static performance from 2000-2005. However, by late 2005, it seemed the world had suddenly realized surging demand from Asia would create a new demand dynamic, causing prices to rise.

Zinc and Lead suddenly had become hot commodities. In 2003, Peru, the world's number 3 producer of lead and zinc, exported $201.3 million worth of Lead and $528.7 million worth of Zinc. By 2005, Lead exports had risen $312 million and Zinc exports to $805 million.

Below I have included two charts of the major sectors in which Lead and Zinc are used in.

As readers can see both metals are used in a variety of industries. Even if Lead and Zinc have a tough 2008, demand for the base metals will not fade. Consider this correction an overdue dose of medicine to cool a surge in prices which in reality was far from justified.


las malvinas said...

Cutting production brings more costs for China than any likely benefits. Workers in China will either get paid less or lose their job, and profits will shift to other countries, such as Peru, as markets look elsewhere for lead and zinc. Cutting production is never the best solution towards manipulating prices.