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China Demand Outlook Supports Basic Materials Sector
Basic materials prices witnessed a strong momentum since mid-2020 due to 1) supply disruptions, 2) global central banks’ monetary easing, and 3) global demand recovery. Most basic metal prices had a short-period correction in 2022 thanks to concerns arising from the Fed’s hawkish stance and China’s sluggish property demand. However, prices bounced back sharply since November 2022 following China’s Covid policy U-turn. The rapid reopening of China’s economy from the zero-Covid policy improved the demand outlook for 2023, which is seen to counter Western recession risks.
As China’s property market steps out of the extremely dark time, the property sector recovery should be much better than expected. The latest new home sales in February recorded double-digit year-on-year growth, while it wasn’t initially expected to turn positive until April. Home buyers are actively getting back into the property market after loosening home purchase conditions, lower mortgage rates and down payments, as well as incentive spending from developers. Therefore, materials demand slowdown from the property side could be limited.
Regarding another key source of demand for infrastructure, China recorded stronger-than-ever issuance of local government special bonds in 2022 to boost the economy. Infrastructure fixed asset investments (FAI) recorded positive growth last year. However, some of these investments have not yet converted into real demand for commodities due to local government leadership changes, funding flow delays, and interruptions of Covid, which will be carried over into 2023. Additionally, China’s State Council has set the 2023 deficit-to-GDP ratio at a 3% deficit target and year-on-year growing special local government bond quota. Therefore, we anticipate infrastructure investment activities to accelerate carrying forward, leading to strong demand for commodities. In particular, the inventory level of copper and aluminium remains historically low, largely due to less capex in the last decade and production control due to ESG reasons, which provided a further cushion for prices.
In addition, China’s energy security and transition pathway imply a delayed coal exit and robust green energy demand in related commodities. Coal prices increased in the last two years after years of capex cuts and supply-side reforms. The temporary power shortages across China also highlighted the importance of thermal power in stabilizing the energy supply. There is a policy shift over the medium term in the context of energy security, though China remains committed to its long-term carbon neutrality target. China’s focus on energy security and transition generates secular demand for related commodities. From renewable power generation to electric vehicles and energy storage, green demand will be robust in the coming years, complementing property as a new growth driver for related commodities.
To summarize the above, we expect demand for basic materials to remain solid despite property decelerating. For most commodities companies, their return on equity (ROE) ratios are at historically high levels, while stocks are trading at low-level valuations, meaning high dividend yields are well cushioned.
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