Special Report - 2009-08-21 - China's Metal Demand

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Special Report - 2009-08-21 - China's Metal Demand

Sali da S peci al R epor t

Chinese Metals Demand: Poised to Correct?
Authored By The Salida Capital Investment Team August 21, 2009

This topical report is authored by the Salida Capital Investment Team on a monthly basis. Each report highlights a current trend, theme or idea of significant interest that we are actively following. The majority of our investment funds are fundamentally driven at the position level however our viewpoint on macro themes is instrumental in determining the strategies and sectors we focus on to explore and uncover investment opportunities. Correctly forecasting and understanding these macro themes has played an instrumental role in our long term successful track record and will continue to be a critical element in how we manage investments going forward.

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Salida Special Report

Chinese Metals Demand: Poised to Correct?

August 21, 2009

Market Outlook
A Sudden Bear Market in Chinese Stocks??? What Gives??? In the midst of all the euphoria and burgeoning optimism over global economic “green shoots”, a funny thing happened. China, the world’s economic bright spot this year, has suddenly seen its stock market tumble. And not exactly a mild tumble — a near bear market plunge of 19.8% in a mere two weeks. How can this be?
Shanghai Composite Index
4,000 400

CRB Commodity Index

3,000

300

2,000

200

1,000

100

0 Jan 09 Apr 09 Jul 09 Source: Bloomberg

0 Jan 09 Apr 09 Jul 09 Source: Bloomberg

Is the “China Story” Susceptible to a Near–Term Setback? The aggressive fiscal and monetary measures undertaken by the Chinese Government over the past several months have been nothing short of stunning. Its 4 trillion yuan (US$586 billion) spending package has been well–documented, as has the country’s highly accommodative monetary policy. Perhaps the most striking indicator of the government’s efforts is the enormous growth in bank loans this year. Interest rates were slashed, reserve requirements cut, and loan quotas abandoned. Beijing told the banks to flood the economy with money — and the banks enthusiastically complied. Through the first six months of 2009, Chinese banks made a whopping 7.4 trillion yuan (US$1.1 trillion) in new loans — three times as much as in the first half of 2008 and considerably greater than the government’s full year target of 5 trillion yuan. What credit crisis!!!

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Salida Special Report

Chinese Metals Demand: Poised to Correct?

August 21, 2009

But enough is enough. Amidst concerns over soaring equities, commodities, and real estate and the growing potential for serious bad loan problems, Chinese officials have allegedly told the largest state–controlled banks to rein in the pace of lending. And it looks like the banks once again are following instructions. July’s loan growth was not only much lower than previous months, but was also down year–over–year — the first such decline since last fall.
Chinese Banks’ Monthly Loan Growth (Trillion Yuan)

2.0

1.6

1.2

0.8

0.4

0.0

-0.4 Jan 2006 Feb 2007 Mar 2008 Apr 2009 May Jun Jul Aug Sep Oct Nov Dec

Source: People’s Bank of China

What happens if this tempering of loan growth continues? In June, economist Wei Jianing of China’s State Council estimated (unofficially) that as much as 20% of new bank lending had gone into stock speculation, and an additional 30% into the property market. A sudden disappearance of easy credit could lead to a plethora of margin calls and forced sales which could reverberate throughout Chinese stock and commodity markets. Thus far (through June) Chinese copper imports have remained at lofty levels. However, in recent days, the price of copper has quietly slipped about 5% from 2009 highs. Meanwhile stories continue to circulate about individuals and small businesses in China having made leveraged bets on an ever rising copper price. Stories also suggest that Chinese production of refined materials and intermediate products continue to exceed demand as local officials frantically keep plants running in order to keep GDP numbers up.

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Salida Special Report

Chinese Metals Demand: Poised to Correct?

August 21, 2009

China Imports of Refined Copper & Alloys (’000t)
400 3.00

Copper Price (US$/lb)

300 2.00 200 1.00 100

0 Jan 2008 Apr 2009 Jul Oct Source: China Customs

0.00 Jan 09 Apr 09 Jul 09 Source: Bloomberg

SHFE Copper Inventories (’000t)
75 120

SHFE Zinc Inventories (’000t)

90 50 60 25 30

0 Q1/09 Q2/09 Q3/09

0 Q1/09 Q2/09 Q3/09

Source: Shanghai Futures Exchange

Source: Shanghai Futures Exchange

With tighter Chinese credit availability and growing inventories, could a material correction in copper (and other metals) be looming?

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Salida Special Report

Chinese Metals Demand: Poised to Correct?

August 21, 2009

Market Opportunity
To be clear, we remain steadfastly bullish on the China story in general and of commodities in particular — at least over the intermediate to long term. However, a combination of aggressive Chinese government intervention and leveraged momentum buying among individual and institutional buyers alike has lifted metals prices dramatically this year, with barely a pause. A sudden tightening of credit availability could certainly prove the catalyst to a material sell–off in commodities held in “weak hands”. The Chinese stock market has already corrected in rapid fashion. Could metals prices be next? While some may argue that a recovering U.S. and/or Europe could pick up the slack if Chinese buying wanes, we are somewhat skeptical. Some restocking in the Western world may indeed occur, but how aggressively? At prices near multi–month highs? With major economies still struggling? Infrastructure building is by nature highly metals intensive, and China will most likely undergo a dramatic transformation in the years and decades ahead. So we have little doubt that real demand will ultimately soak up tremendous quantities of copper and other commodities. But it is also entirely possible that the market has moved too far too fast. With the likelihood of tighter Chinese credit conditions, higher inventories, and the always tense September–October period approaching, we feel that a more cautious positioning is warranted for the near term. That said, we would not expect an outright collapse or anything approaching last year’s carnage. Central banks worldwide are still printing money aggressively and safe haven investments (i.e. treasuries) are offering miniscule yields. As such we would look to boost exposure to metals and other commodities on any material weakness. Buy the dips!

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Salida Capital was founded in 2001, and is a leading international alternative investment management firm committed to providing innovative investment solutions that deliver superior absolute returns in the mid to long term. Through a number of funds and separately managed accounts, Salida Capital offers world class investment expertise, innovative products, disciplined investment strategies and a commitment to transparency and service excellence.

Funds advised by Salida Capital

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Salida Multi Strategy Fund — Inception: November 2004 Salida Strategic Growth Fund — Inception: Fall 2009 BTR Strategic Growth Fund — Inception: March 2009 BTR Global Energy Fund — Inception: January 2006

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Past Reports
World Markets Watch World Markets Watch World Markets Watch World Markets Watch Special Report: Uranium Shortage Looming? Special Report: U.S. Natural Gas: A Coiled Spring Special Report: Cautious on Copper ... For Now Special Report: Chinese Metals Demand: Poised to Correct? The Energy Report The Energy Report The Energy Report Salida Capital 2 Bloor Street W. Suite 2700 Toronto, ON, Canada M4W 3E2 Phone: 416 849 2555 Toll Free: 866 213 0291 Fax: 416 849 2552 Email: [email protected] April 2009 May 2009 June 2009 July 2009 April 2009 May 2009 June 2009 August 2009 June 2009 July 2009 August 2009

This report is published by Salida Capital Corp. (“Salida”). The information contained in this report does not constitute a recommendation by the authors or Salida to buy or sell any of the securities, commodities, currencies or other financial instruments or assets discussed herein. This report has been prepared using information from sources that the authors and Salida believe to be reliable, however neither the authors nor Salida guarantees the accuracy of such information. This report does not constitute and may not be used for the purposes of effecting an offer or solicitation of shares of any “Salida” or “BTR” Funds (the “Funds”). Important information about the Funds is contained in their offering memorandums, including a detailed description of the Funds’ investment objectives, investment strategies and risk factors. Information in this report is qualified in its entirety by the relevant offering memorandum.



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