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Commodity Rally Threatening $460 Billion China Bonus From Slump

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  • Collapse in prices helped reduce import costs in 2015
  • More expensive raw materials complicate bid to spur growth

China got a $460 billion break annually during the collapse in commodity costs, so this year’s rally in everything from oil to iron ore is starting to erode the bonus of cheap imports.

That complicates President Xi Jinping’s efforts to prop up faltering growth in the world’s second-largest economy. Rising prices take money from consumers who use more food, energy and metals than any others in the world. It also increases inflationary pressure, limiting the scope of the country’s central bank to stimulate the economy through further monetary easing.

“Any significant upturn in commodity prices such as oil and gas and iron ore would therefore have a net negative impact on the Chinese economy,” Rajiv Biswas, Asia-Pacific Chief Economist at IHS Global Insight, said in an e-mail.

Base metals like zinc and copper are off to their best start since 2012, crude is set for its biggest monthly gain in almost a year, and iron ore used to make steel has surged into a bull market after touching a record low in December. While domestic producers of those raw materials benefit, China is a net importer, so those gains mean higher costs and more pressure on profit margins for industries already struggling with slowing growth.

The following charts illustrate some of the costs and benefits of the fledgling recovery in commodities for China.

Crude oil’s 35 percent plunge last year saved China about $320 billion, according to Kenneth Courtis, chairman of Starfort Holdings and former Asia vice chairman at Goldman Sachs Group Inc. The rest of the savings came from metals, coal and agricultural commodities. The country gets about 60 percent of the oil it needs from overseas. With prices slumping as low as $27 a barrel this year, refiners have been on a massive buying spree, importing record amounts and filling strategic stockpiles to an estimated 80 percent of operational capacity.

Prices have rallied more than 40 percent, near $40, which may reduce China’s overall commodity bonus to about $440 billion on an annual basis, according to to Courtis. While that reduction has little impact on the economy, prices sustained at $55 to $60 would start to generate more serious headwinds, he said. China would probably slow purchases if oil topped $70, according to Shi Yan, a Shanghai-based analyst at UOB Kayhian Investment Co.

The rally isn’t all bad for China, partly because it would increase the value of the inventory stockpiled when prices were lower. Oil at $40 also helps the cash flow of domestic producers including PetroChina Co. and Cnooc Ltd., who have cut production because most need prices at about $50 to break even, according to Shi. A rally will encourage more exploration and may attract private investment, said Tian Miao, a Beijing-based analyst at North Square Blue Oak Ltd.

China’s steel mills lost money for most of last year, even as the cost of iron ore plunged, because of a global glut and weak demand. Now, iron ore has surged 21 percent this year, including an unprecedented 19 percent jump on March 7 to an eight-month high of $63.74 a metric ton. That’s putting more pressure on an industry already battered by the worst margins since at least 2007. After years of economic expansion, China has more than 400 million tons of surplus steel capacity.

The degree of pain from more-expensive iron ore depends on whether steel prices can keep pace. Spot rebar in China has risen about 18 percent this year, helping lift margins into positive territory for the first time since May. An improvement in profits may encourage some shuttered plants to resume output, according to Xu Xiangchun, chief analyst at Mysteel Research.

Prolonging the life of unprofitable mills is going to complicate the government’s efforts to restructure the industry by closing some down, though it would be good news for the 500,000 workers whose jobs are at risk.

“Rising prices may slow down the country’s campaign to cut oversupply as producers receive more incentives from the market to keep capacities rather than shutting them down,” Xu said.

Either way, the recovery will be a boon to domestic iron-ore mines hurt by a flood of cheap supplies from Australia and Brazil, provided the rally lasts. Many, from Goldman Sachs Group Inc. to China Iron & Steel Association, say this year’s price jump is a blip that isn’t sustainable. According to the median of nine estimates in a Bloomberg survey, prices will return to $41 in the second quarter.

China’s been buying gold in a big way, including during the precious metal’s three-year slump through 2015. This year, prices are up 16 percent, touching a 13-month high of $1,284.64 an ounce on March 11. In July, the central bank disclosed that it had expanded gold holdings by 57 percent in six years as the nation sought to diversify its foreign exchange reserves. The People’s Bank of China has increased its hoard every month since then, and it reached about 1,788 tons by the end of February. This year’s advance in bullion -- the best performance of any raw material on the Bloomberg Commodity Index -- has increased the value of those assets.

Only about 2 percent of China’s reserves are in gold, compared with 67 percent for Germany and 73 percent in the U.S., according to data from the World Gold Council. As prices rise, the country’s ambition to amass reserves commensurate with its economy is getting more expensive to fulfill, and that may slow demand, according to Vyanne Lai, an economist at National Australia Bank Ltd.

Last year, China was the world’s largest consumer of gold jewelry at 783.5 tons, compared with 654.3 tons bought by Indians. While the price rebound is going to make everything from rings to necklaces more expensive, it’s a boon for miners in what’s also the world’s biggest producing country. Zijin Mining Group Co. shares have climbed 23 percent this year in Hong Kong after losing 7.7 percent in 2015.

— With assistance by Ranjeetha Pakiam, and Jing Yang

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