Tuesday 5 June 2012

Chinese defaults on purchase contracts


Chinese Purchasers Default on Commodity Contracts
Chinese buyers are either deferring or defaulting on iron ore and coal purchase contracts as inventories in China rise and prices fall. At the end of last month, there were at least six thermal coal cargoes—from the United States, Colombia, and South Africa—affected by these defaults


3 June, 2012


Moreover, Chinese steel mills are now postponing purchases of iron ore, especially from Brazil’s Vale. Purchasers in China have been seeking to delay deliveries of the commodity since October.

Similarly, Chinese copper purchasers are re-exporting cargoes, and since March they have been postponing deliveries.

What’s going on? There are two theories. Some think China’s buyers are defaulting to take advantage of lower prices. According to this theory, they will re-book cargoes soon, something they did in 2010.

In 2010, Beijing claimed GDP growth of 10.4%, and the actual rate was probably higher. This April, however, the story was different. Growth was at best zero that month, and initial indications for May tell us the economy continued to deteriorate. Tumbling growth rates mean the second theory—Chinese enterprises cannot use all the commodities the country has purchased—is the far better one.

You don’t need to be an economist to find evidence of China’s sudden deceleration. In the port of Qingdao, warehouses are so full that workers are stockpiling iron ore in granaries. In Shanghai, they are putting copper in car parks.

The inventory of copper in bonded storage in that city is twice the 300,000 metric ton average of the last four years. Zhang, the manager of a bonded warehouse in Yangshan Port in Shanghai, notes that the turnaround for copper used to be one or two months, but now it is at least six. “The destocking is happening very, very slowly,” he told Reuters.

And it’s no mystery why copper is moving out of the port at snail speed. “New orders have slowed quite substantially from a year ago,” says a manager at a large Chinese factory making copper tubing. “With demand so weak, we’ve scaled back operations, shut one production line and reduced the number of shifts.”

Copper is not the only metal that’s sitting in Shanghai’s port. There, stockpiles of iron ore are a third larger than the average 74 million metric tons.

Need more proof of falling iron ore demand? Chinese steel traders have committed suicide, and BHP Billiton, the world’s biggest miner, put its iron ore and copper expansion plans, recently announced to meet Chinese needs, on hold. Rio Tinto, the other giant Anglo-Australian mining concern, is following suit.

The problems are reflected across the Chinese manufacturing sector. The HSBC/Markit PMI for May took a tumble, falling from 49.3 to 48.4. The big decline was mirrored in the semi-official index from the China Federation of Logistics and Purchasing, which plunged to 50.4 from April’s 53.3. The magnitude of the change in Beijing’s index took analysts by surprise.

Should we worry? Yu Song of Goldman Sachs says manufacturing activity is not as weak as the PMI data suggests, but that assessment appears to be just more cheerleading from sell-side institutions, which have made few correct calls on the Chinese economy this year.

Analysts are loath to acknowledge that China’s economy has hit an inflection point. In this new environment, Beijing’s stimulus program, contained in a series of recent announcements, appears insufficient to have a lasting effect. Of course, the expansionary measures could lift the country’s requirements for commodities, but that bounce probably will not occur until the next quarter and be short-lived at best.

In the meantime, China remains moribund. As Reuters implies, stationery cargo trains in Qingdao’s port are a telling indication of the current state of the Chinese economy


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