Commodities Comment. An imbalance in China s commodity trade GLOBAL. Latest news

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1 GLOBAL LME cash price % change US$/tonne day on day Aluminium 1,868.1 Copper 5, Lead 2, Nickel 1, Tin 19,395.2 Zinc 2,7.5 Cobalt 5,75. Molybdenum 14,897. Other prices % change day on day Gold (US$/oz) 1, Silver (US$/oz) Platinum (US$/oz) Palladium (US$/oz) Oil WTI USD:EUR exchange rate AUD:USD exchange rate LME/COMEX stocks Tonnes Change Aluminium 2,11,55-16,325 LME copper 288,525 26,55 Comex copper 117,464 1,6 Lead 189,725 Nickel 386,118 5,22 Tin 5,3-29 Zinc 383,85-2,175 Source: LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, March March 217 An imbalance in China s commodity trade China s preliminary commodity trade data for February made interesting reading. On one hand, iron ore and coal imports remained strong, while copper concentrate imports recovered after a weak January. On this side, the Chinese commodity business model seems very normal, with plentiful appetite to soak up raw materials. However, the other side of the model exporting finished products was very weak in February, with annualised steel and aluminium export volumes the lowest since early 214 something we discussed in this note. Of course, Chinese trade data can always be unusual around Chinese New Year. But shifts tend to impact imports and exports equally, and taking combined January-February data into account paints the same picture. Such an imbalance can point to stronger domestic demand. However, it can also point to inventory build, which has certainly been the case for steel, aluminium and copper. Demand now needs to come through strongly to pull this material through the chain, but physical indicators don t point to this happening as of yet. Lower Chinese metal exports also mean less deflationary pressure being shipped to international markets, helping reference prices and supporting the reflation push, for now at least. Latest news Nickel prices fell 4.2% to $1,142/t after some more detail on Indonesian ore export legislation was published. These suggest miners with smelters will be allowed to ship as much nickel ore and bauxite as the input capacity of the smelters. While the application process will take time, this implies ore exports could range from a minimum of 3kt Ni (Antam s current capacity) to >2kt Ni. Please see our report from yesterday for scenarios around ore exports. Metal Bulletin and other media outlets have been reporting that three sellers have offered Q2 main Japanese port (MJP) aluminium premiums of $135/t into Japan, up considerably on the $95/t set in Q1. The lift in these offers is linked to gains in the US local premium and some smelter outages in Australia (Boyne and Portland), which is a major supplier of ingot to Japan. Buyers, however, are said to be targeting premiums in the range of $11-115/t, noting the recent decline in the US mid-west premium to under 1c/lb. Are you expecting the US economy to accelerate as growing consumer and investor confidence is supported by growth-supportive policies from the new Administration? Well think again, says our US economy David Doyle in a new report, Fortress America Demographics, lower potential and the Fed. While such measures might work short-term to deliver a boost, medium-term the US economy s economic strength will be set by a combination of labour force and productivity growth. The latter has been weak for years, at around 1% growth per year, but it is the former that is really concerning as the population ages. David believes it is now just.4% a year, even assuming the participation rate increases. Put this together and he sees long-term GDP growth to be just 1.4%, down from his previous estimate of 1.8%. The consequences of this are that he expects 1yr Treasury yields to peak at just 2.3%, from 2.7%, and Fed short-term rates at just 1.75%, from 2.%, a target he now expects to be reached in early 218. Please refer to page 7 for important disclosures and analyst certification, or on our website

2 million tonnes, annualised Jan-14 An imbalance in China s commodity trade China s preliminary commodity trade data for February made interesting reading. On one hand, iron ore and coal imports remained strong, while copper concentrate imports recovered after a weak January. On this side, the Chinese commodity business model seems very normal, with plentiful appetite to soak up raw materials. However, the other side of the model exporting finished products was very weak in February, with annualised steel and aluminium export volumes the lowest since early 214 something we discussed in this note. Of course, Chinese trade data can always be unusual around Chinese New Year. But shifts tend to impact imports and exports equally, and taking combined January-February data into account paints the same picture. Such an imbalance can point to stronger domestic demand. However, it can also point to inventory build, which has certainly been the case for steel, aluminium and copper. Demand now needs to come through strongly to pull this material through the chain, but physical indicators don t point to this happening as of yet. Lower Chinese metal exports also mean less deflationary pressure being shipped to international markets, helping reference prices and supporting the reflation push, for now at least. High imports + low exports = inventory build To us, China s commodity business model has been pretty clear over the years. Purchase/secure raw materials as far upstream as possible, build enough capacity to process this material and ideally export a small amount of refined product to buffer against inflation. Only when this value chain gets disrupted do commodity markets see some dislocations. And February s figures certainly showed an imbalance. Not on the raw materials side however, where iron ore imports (adjusted for days in the month) were essentially flat at January s high level of 1,88mtpa, despite weaker Australian shipments in the month (iron ore import value was up 95% YoY). Meanwhile, following the weak January imports we discussed in this note, copper concentrate imports rebounded to 18.6mtpa gross weight the third highest month on record and well above the 216 average. There was clearly still strong appetite for raw material purchases by Chinese buyers through February. Fig 1 In what has typically been a weak month for Chinese iron ore imports, February s were very strong Fig 2 Copper concentrate imports recovered from a weak January back towards Nov-Dec 216 levels Mtpa 1,25 China monthly iron ore imports 23 China's copper concentrate imports, gross weight 1, , Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: China Customs, Macquarie Research, March 217 Source: China Customs, Macquarie Research, March 217 On the refined product export side however, the figures were noticeably weak. As we discussed here, Chinese steel exports in Q4 216 were the lowest since early 214. Q1 217 will be even lower however, with February s export volumes of 75mtpa a full 44% below June 216 s peak. Meanwhile, unwrought aluminium exports also dropped to 3.39mtpa, the lowest since February 214. China s metals export machine is sputtering. 8 March 217 2

3 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Mar-16 May-16 Jul-16 Sep-16 Nov-16 mtpa Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 million tonnes, annualised Fig 3 Finished steel exports have slumped in recent months Fig 4 while aluminium exports have also weakened to levels last seen in early Finished steel net exports Finished steel 3mma ktpa 7, 6, Unwrought aluminium exports 1 8 5, 6 4, 4 3, 2-2 2, 1, Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: China Customs, Macquarie Research, March 217 Source: China Customs, Macquarie Research, March 217 Often such anomalies can be put down to Chinese holiday effects, but in most cases February was just an extension of the trend seen over January (and previous months). But what has brought about this fall in exports? Certainly, with the industrial recovery domestic Chinese demand has improved, soaking up material. And with narrowing pricing differentials, export markets are less attractive. However, in the post-chinese New Year period, strong demand growth is unlikely to be the February answer. Rather, the February imbalance reflects expectations of stronger domestic demand. Our recent bullish steel survey perhaps highlighted this fact best. However, with output remaining strong and demand seasonally weak the net result has been inventory build within China, at various stages of the value chain. For aluminium, having waited all year for Chinese smelter restarts over 216, recent months have seen a rapid acceleration in output. Indeed, Chinese production is currently running up 5mtpa YoY a low base certainly helps, but this is still a record absolute gain. While government-driven cuts will come, these will be focused in the winter months from this coming October-November there has been no impact yet. Seasonal uplifts in inventory over the weaker demand period during and immediately after Chinese New Year are very much the norm. The YTD gain in 217 however is dramatic, with a tripling of visible inventory thus far. We are now above 216 s peak levels, and the build is continuing, aided by strong output in expectation of a demand uplift. The same trend has been seen in visible copper inventories. Fig 5 Restarts in China have seen an aluminium production surge Fig 6 while recent weeks have seen inventories climb above 216 peaks YoY growth in Aluminium output ex-china China ' tonnes 1,4 1,2 1, SHFE on-warrant stock Non-SHFE stock SHFE off-warrant stock Source: IAI, Macquarie Research, March 217 Source: CRU, SMM, Macquarie Research, March March 217 3

4 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 MySteel trader steel inventory, mn tonnes Much the same is true in steel, where trader inventories have accelerated quickly since the start of the year and have now surpassed peak levels seen in both 215 and 216. This reflects a high degree of confidence, as evidenced by our steel survey, of continued order strength in the coming months. This is essentially pure physical speculation, but has certainly been helped by more ready availability of credit than in past years. As a result, Chinese steel output accelerated strongly in early February. Meanwhile, some of the strong iron ore imports have been evidenced in port inventory gains as widely discussed by market participants. In our view, this reflects an efficient market where marginal supply has reacted to price prompts. But in any case this increased volume has found purchasers with no discernible impact of price (certainly until this week). Fig 7 The steel inventory build by Chinese traders has been more aggressive this year Long products Flat products Fig 8 while the continued build in iron ore port stocks has been widely discussed mn tonnes Iron ore port stock at 31 ports - LHS % 13 % owned by traders - RHS Source: Mysteel, Macquarie Research, March 217 Source: Mysteel, Macquarie Research, March 217 High Chinese refined exports are of course typically a source of deflationary pressures to global markets. The recent pullback has certainly eased these pressures. This comes at a time where developed world demand growth continues to recover. As our Global Macro team has noted, we are is now 15 months past the nadir of the global industrial production cycle and the OECD LI is now in positive territory. Indicators from metals markets continue to suggest reasonable developed world demand growth at the present time. This combination of events should see wider reference price gains across commodities, helping the reflationary trend. And certainly, over the past few months aluminium, steel, stainless steel and other metal prices have trended higher. Given output levels are high, we reiterate that supply curtailments have not been the key reason (these will become more important from Q4 217), but rather that apparent demand (whether through real demand or inventory build) has picked up. We would note however that, despite the sequentially weaker February data, the WSD World Steel Export HRC price actually fell in the month. To us, this highlights that two-tier commodity pricing via protectionist policy is already coming through in steel, with domestic prices generally outperforming still oversupplied export markets, despite China s pullback. This should be somewhat of a red flag for steel producers exposed to the export market. Given the level of inventory build in China, demand now has to pick up strongly to pull this material through the chain. However, while demand is clearly significantly better than this time last year, current indicators aren t showing the aggression we might have expected from the strong sentiment seen over 217 to date. Indeed, there seems an increasing chance that demand is undershooting what were admittedly high expectations. Recently, copper premiums have dropped back to minimum warehouse offering levels. Physical market prices are below SHFE in many cases, while just this week the iron ore price looks to be cracking. The argument could be made that the post-new Year end-user ordering was being delayed until after the assemblies held last weekend, but with the government clearly starting to worry more about inflation and tightening policy at the margin, sentiment is likely to be weakening. We reiterate that in the view of our Chinese Economist Larry Hu, we are passing through the peak of China s growth cycle with headwinds likely to be seen over Q2. 8 March 217 4

5 1 Jul Jul Jul Aug Aug Aug Aug Sep Sep Sep Oct Oct Oct Nov Nov Nov Dec Dec Dec Jan Jan Jan Feb Feb Feb Mar 217 $/tonne When inventories are high, this situation poses a potential problem. We will be tracking how quickly visible inventories are being run down over the coming weeks as a gauge of whether demand is meeting expectations. In particular, we will be looking at the downward gradient of steel trader inventories relative to past years. If this is at normal pace, worries may again dissipate. If slower than usual, traders will stop ordering from mills, mills will shift from expecting output growth to output declines, and iron ore may suffer another of its periodical whiplashes. As always seems to be the case at this time of year, incremental Chinese commodity-related data points will be closely scrutinised for a gauge of wider economy health. Fig 9 Despite lower Chinese shipments, steel export benchmarks fell over the course of February Fig 1 The Chinese refined copper premium has dropped sharply in recent times Change in average World Export HRC price October November December January February Shanghai copper premium, $/tonne Source: WSD, Macquarie Research, March 217 Source: Metal Bulletin, Macquarie Research, March March 217 5

6 Wednesday 8 March 217 Prices Closing price * Closing price * 8-Mar-17 8-Mar-17 7-Mar-17 7-Mar-17 % ch. day 217 YTD Ave 216 US$/tonne US /lb US$/tonne US /lb on day US$/tonne US$/tonne LME Cash Aluminium 1, , ,46 1,65 Aluminium Alloy 1, , ,287 1,555 NAASAC 1, , ,452 1,74 Copper 5, , ,656 4,863 Lead 2, , ,812 1,872 Nickel 1, , ,258 9,69 Tin 19, , ,961 18,6 Zinc 2, , ,213 2,95 Cobalt 5,75 2,32 5,75 2,32. 32,299 25,655 Molybdenum 14, , ,148 14,453 LME 3 Month Aluminium 1, , ,462 1,61 Aluminium Alloy 1, , ,298 1,577 NAASAC 1, , ,468 1,725 Copper 5, , ,669 4,867 Lead 2, , ,813 1,878 Nickel 1, , ,32 9,657 Tin 19, , ,956 17,912 Zinc 2, , ,22 2,12 Cobalt 5,75 2,32 5,75 2,32. 32,31 25,758 Molybdenum 15, 68 15, ,148 14,472 * LME 2nd ring price - 17 hrs London time. Year-to-date averages calculated from official fixes. Gold - LBMA Gold Price (US$/oz) Silver - LBMA Silver Price (US$/oz) Platinum - London 3pm price (US$/oz) Palladium - London 3pm price (US$/oz) Oil WTI - NYMEX latest (US$/bbl) EUR : USD exchange rate - latest AUD : USD exchange rate - latest 1,29 1, , Exchange Stocks Change since last report Cancelled End-16 Ch. since (tonnes) 8-Mar-17 7-Mar-17 Volume Percent warrants stocks end-16 LME Aluminium 2,11,55 2,117,875-16, % 83,25 2,22,175-1,625 Shanghai Aluminium 221,58 221,58.% 1,722 12,336 Total Aluminium 2,322,68 2,338,933-16, % 83,25 2,32,897 19,711 LME Copper 288, ,975 26,55 1.1% 123,5 311,825-23,3 Comex Copper 117, ,44 1,6.9% - 8,112 37,352 Shanghai Copper 313, ,873.% - 146, ,275 Total Copper 719, ,252 27,61 4.% 123,5 538, ,327 LME Zinc 383,85 386,25-2, % 175,8 427,85-44, Shanghai Zinc 199,33 199,33.% - 152,824 46,29 Total Zinc 582, ,58-2, % 175,8 58,674 2,29 LME Lead 189, ,725.% 69, ,9-5,175 Shanghai Lead 68,419 68,419.% - 28,726 39,693 Total Lead 258, ,144.% 69, ,626 34,518 Aluminium Alloy 13,28 13,28.% 96 12,98 3 NASAAC 119,76 119,76.% 34 97,38 22,38 Nickel 386, ,96 5,22 1.3% 16,53 372,66 14,52 Tin 5,3 5, % 1,185 3,75 1,28 Source: CME, LBMA, LME, Reuters, SHFE, Macquarie Research 8 March 217 6

7 This publication was disseminated on 8 March 217 at 2:57 UTC. 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