Is China Leading a Global Rebound?

Given the news of China's surging raw materials imports in the first quarter, it would be easy to jump to the conclusion that the country is quickly on its way to recovering its former economic vigor. Copper and iron ore imports are breaking records, coal companies expect China to become a net importer for the first time in 2009, and the country's demand for imported virgin fiber has surged in recent months. However, after looking at the data more closely, a few themes emerge that point to alternative explanations for China's apparently healthy appetite for raw materials. Further, while we see signs that China's stimulus plan is taking hold, other trends in raw materials corroborate the fact that China's export activity is still relatively weak.

China appears to be stockpiling some key materials for strategic purposes.

China is the world's largest consumer of copper, accounting for 27% of world demand in 2008, and it's also the largest importer. China's imports of copper rose 33% in the first quarter of 2009 over the year-ago period, according to the country's customs agency. This surge in China's imports is likely partly responsible for copper's rise from below $1.30 per pound in late 2008 to around $2.00 today. Rumors abound that China's State Reserve Bureau (SRB) is building strategic inventories of copper, although this is hard to independently verify because SRB inventory levels are not public information. However, strategic purchases of copper at this point make sense for two possible reasons. First, copper is an actively traded hard asset that can be used as a store of value by those worried about a potential decline in the U.S. dollar. Second, China may simply be taking advantage of an opportunity to "buy low" for a commodity that's an important component of economic activity (copper traded hands for $4.00 in July 2008).

China's stimulus plan seems to be driving demand for infrastructure-related materials.

Although demand for coal from the power sector declined in the first quarter of 2009, according to the China Electricity Council, Chinese coal production grew in the first quarter and imports have been strong in recent months. This apparent disconnect can be explained by the relative mix of demand for coal. While in the United States the lion's share of coal goes into electricity generation; in China the industrial sector claims a significant but still-small share of coal output. It's possible that demand from coal-intensive infrastructure-related industries--such as cement--is supporting overall demand for coal. China is the world's largest producer of both coal and cement.

Low international commodities prices make some imports more attractive.

We've mentioned that China's coal imports have been strong recently. Another likely contributing factor is the lower price of imported coal relative to domestic coal. While China's domestic coal producers have been negotiating with power companies for an increase in contract prices (despite weaker demand from the power sector), China's power companies have been looking to lower-cost imports to manage costs.

China's imports of iron ore (a key ingredient for steelmaking) also spiked dramatically in February and March, and stockpiles of iron ore appear to be building at Chinese ports, according to data from the China Mining Association and Mysteel.com. The larger iron ore producers have been selling their iron ore to Chinese customers at a discount. While China is endowed with a large amount of iron ore reserves, its ores are lower grade than those in Brazil and Australia, for example. Based on comments from the China Iron & Steel Association, it's possible that small Chinese steel mills are taking advantage of the opportunity to buy higher-grade imported ore at attractive prices. Previously, imported ore was only available to large mills.

We can see a similar trend in the recent surge in China's imports of virgin fiber (plant material used to make paper). Much of China's domestic virgin fiber supply is derived from straw and other so-called "vegetable" materials, a feedstock making the fiber ill-suited to high-quality papers used in glossy magazines and office papers. By contrast, imported virgin fibers from Canada, Russia, Indonesia, and Brazil from trees have excellent physical characteristics for printing and writing papers. Foreign virgin fiber prices have fallen enough that imports can now compete on price in addition to quality, so mills switching to imports is a no-brainer.

The mix of fiber imports corroborates weak manufacturing exports.

We've mentioned the recent surge in China's imports of virgin fiber, which stands in contrast to still-weak imports of recycled fiber, despite a collapse in prices for both materials. Recycled fiber imports are primarily used for the manufacture of corrugated boxes, a significant portion of which are filled with goods bound for overseas markets. By contrast, the bulk of Chinese virgin fiber imports find their way into printing and writing papers, for the most part destined for domestic markets. Consequently, all else equal, recycled fiber imports tend to expand or contract along with Chinese manufacturing exports, whereas virgin fiber imports correlate more with domestic printing and writing paper consumption. Therefore, the relative strength of virgin fiber imports would seem to indicate a relatively strong domestic economy and relatively weak export activity.

Conclusions
Do macroeconomic figures support the themes we're seeing in raw materials imports? In many cases, they do. Fixed asset investments were strong in the first quarter, driven by investments in transportation, according to the National Bureau of Statistics in China. It appears that the Chinese government's stimulus program has begun in earnest. This helps explain the strength in coal demand that we're seeing. Meanwhile, China's exports were weak during the first quarter, which sheds light on the relative strength of virgin fiber imports compared with recycled fiber imports.

On the other hand, the surge in imports of copper and iron ore do not lead us to conclude that China is set for a swift and full recovery in economic activity. Rather, we think the strength in these imports can be at least partly explained by strategic moves by the Chinese government or rational decisions by domestic steel mills.