Will China's Residential Construction Bubble Hit Copper, Zinc and Nickel Industrial Metals?

Nov 10, 2010 – 03:01 AM

By: Mike_Stall

China is the world’s largest consumer of copper, zinc and nickel and also among the leading consumers of other base metals. The country has one of the fastest growing auto sector (which has overtaken the US in size) and has plans for rapid expansion of railroads and other infrastructure segments. Not surprisingly, China’s demand growth is expected to be the single most important factor in determining the direction of metal prices.

With a substantial emphasis on infrastructure and construction, the health of the construction sector in China is worth a look to corroborate future prospects of industrial metals. In the present report, we have analyzed China’s construction sector and its likely impact on industrial metals in the medium to long-term. We have divided the construction sector report into two parts to avoid overkill. In this part we will analyze the shape of the residential construction segment, which is allegedly slowing down after a phase of tremendous expansion. In the subsequent part we will emphasize on the more significant sectors of non-residential construction and infrastructure.

China’s residential construction sector comprises approximately 21% of the total construction in the country. China’s residential construction market has grown rapidly to about 186 million square meters of new building per annum since the privatization of over 70% of the housing inventory in the last decade. Construction levels in Beijing alone have outpaced construction levels in entire Europe – a testimony to the magnitude of building activities happening in China.

A momentous climb in middle class income levels has led to higher demand for modern day luxury buildings. The swelling population in cities such as Shanghai necessitates higher requirements of new buildings every year. China also has plans to build a number of satellite cities and townships to cope with the massive expansion in the upcoming years. With Japan and the US stagnating, China remains the global hotspot spurring construction investments.

The massive Chinese stimulus with emphasis on infrastructure saw the power and enormity of China’s ability to drag metal prices out of any potential downside. Copper and other industrial metal’s solid performance in the midst of the global recession is evidence of how influential China’s infrastructure spending could be. The impact of the stimulus is yet to wear off and we expect infrastructure activities initiated as part of the stimulus plan to continue pulling up metal demand for some more time yet. Also, China’s emphasis on infrastructure is not a new stand – it only underlines the continuing growth happening in the region. Much of these factors will remain a key driver of metal prices in the upcoming years as well.

Metals Overview

After rallying in 2009, industrial metals have had a mixed year so far in 2010 as the global economic scenario remained weak in the first half. China’s metal imports, a key driver of the rally in the second half of 2009, lost pace leading to speculations that demand for metals in the developing markets is drying up. Although metal prices have picked up over the past few months, the withdrawal of Chinese purchase plans is likely to affect metal prices in the upcoming months.

The World Bank and IMF’s revised global economic growth outlook indicates a marginal improvement in 2011; but the bias is toward a more protracted and muted development. Macroeconomic data from the major economies also indicate a pause in metal prices. The unemployment data from the U.S., Europe and Japan dampen the prospects of metals in the short term. However, the role of developed economies in shaping metal prices is expected to be nominal in the next few years with developing economies accounting for a clear majority of the demand. The silver lining is that the developing nations are continuing to grow at an impressive pace to keep metals supported.

Despite the host of negativity in the metals market, LME and Shanghai copper inventories have witnessed a drastic reduction this year. The supply side has also been showing signs of fatigue – new exploration activities have stalled and ore grades have started to deteriorate. The dollar has also not been strong and that has helped prices of dollar denominated metals. It is evident that demand is a less important factor now in determining copper prices. Nonetheless, investors looking to gain in the long term should be prepared for a correction because of a perceived lull in Chinese demand.

Impressive growth for residential construction in China

China’s construction sector has demonstrated impressive growth in the past few years. In fact, contribution of the sector to the country’s economic growth has increased from a mere 3% in the 1990s to 17% in 2009. The total construction expenditure in 2008 was estimated at approximately USD 1.2 trillion making China the second largest housing market in the world, after the U.S. In addition, China’s construction sector witnessed double-digit growth (compound annual growth rate) during the past decade. That’s a whopping number given that the global growth was in the range of 5-6% during the same period.

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