SINGAPORE (Reuters Breakingviews) - President Xi Jinping is trying to wean China off its property-based, debt-fuelled economic model. The transformation will cool growth in the world’s second-largest economy after years of rapid development. Investors are worried but risk ignoring the structural changes underpinning the country's continuing voracious appetite for raw materials.
Take the $300 billion copper market. China imports over 60% of the metal’s globally traded volume. "When it comes to copper, the thinking usually goes that copper equals property, property equals China," said one commodities trader. "And because China property is down, copper must be down too."
True, the country's vast real estate sector, which powers a quarter of GDP and some 40 other sectors from construction to home appliances, is still finding a bottom. New construction starts by area have shrunk by another 23% in the year to October from an already battered 2022. Coupled with Beijing's geopolitical fissures with the West, ranging from a technology race with Washington to its cosiness with Moscow and its position on Taiwan, investors are having cold feet about a broad set of Chinese assets. China recorded its first-ever quarterly deficit in foreign direct investment – $11.8 billion between July and September.
But two nuanced trends complicate the picture. First, as much as Xi frets about housing bubbles, he is still keen to prevent social unrest, given that ordinary Chinese store 70% of their wealth in property. That's why he wants to ensure distressed developers like China Evergrande (3333.HK) finish building the apartments that they have pre-sold to mortgage payers. By October, China still had about 8.2 billion square metres under construction – roughly 80 million typical three-bedroom homes. Copper tends to be used in a building’s late stages, so the potential demand loss arising from the property crisis is likely to be less severe than for iron ore, which is used more prominently at the start of construction.
Second, Xi's mission to shift the country's economic drivers from real estate to green and high-tech industries is accelerating. When China’s top leaders set priorities at the Communist Party’s twice-a-decade finance conference on Oct. 31, they explicitly asked that more financial resources go into these investments. That means state-owned banks will probably be guided to lend more to electric cars, wind and solar energy, artificial intelligence and advanced chips. Those industries need copper and other metals.
Thus, while the share of China's “new economy” remains small versus the old growth engines, its rise is also creating new demand for commodities. Copper, for one, is essential in making electric motors and batteries, as well as in power grids, and other efforts to boost renewable energy. In wind energy, for example, China added more generation capacity in the past two years than over the previous seven and will grow its grid-connected wind power at a 10-year compound annual growth rate of 11% to 2.38 terawatts at the end of 2032, according to Wood Mackenzie.
That’s why China's copper demand will still rise by 4 million metric tons from the 2020 level to around 18 million tons per year in 2030, according to estimates by commodity trading group Trafigura. That compares to an increase of 5 million tons in annual demand from 2010 to 2020. And China's copper demand has grown by 8% this year, faster than the 5% Xi is targeting for overall GDP growth. Copper prices followed the boom and gloom surrounding China's pandemic reopening this year, yet they did much better than the collapse threatened by the property downturn. The most traded copper contract on the Shanghai Futures Exchange (SHFE) still rose about 4% this year to $9,367 a ton, while three-month copper contracts on the London Metal Exchange are about 3% higher. Chinese producers are having a blast: shares in Shanghai-listed Zijin Mining (601899.SS) have gained almost 20% this year.
It’s similar for aluminium, which is prominent in property construction but also in EV components, such as those that enclose and protect the battery pack, and infrastructure like charging stations. China's annual aluminium demand rose by 18 million tons from 2010 to 2020 and is forecast to grow by another 13 million tons to over 50 million tons a year in 2030, per Trafigura. Aluminium prices on the SHFE have risen by more than 1% this year, outperforming global prices on the London Metal Exchange, which have slumped by more than 8%, per ING analysts.
Together, these factors are acting as a floor for Chinese growth. This month, the International Monetary Fund upgraded China's GDP growth for 2023 and 2024. It now expects the country’s output to expand by 4.6% in 2024 from a 4.2% estimate in October. The People’s Republic contributed 35% of world GDP growth in 2019; it would still account for 27% of that in 2024, even if it expands by a sub-par 4%, according to Breakingviews calculations based on IMF and World Bank data. That's partly because other regions, like the United States, are expected to slow.
To be sure, the phasing out of real estate would hit some commodities more than others. For example, China's steel-reliant construction sector may grow at around just 2.5% a year over the next 10 years, per Oxford Economics analysts, which should concern iron ore exporters like Australia. But even then, the blow to prices might be far from extreme. China accounts for nearly 70% of global demand for iron ore so when its housing market slumped in 2015, prices plunged to an all-time low of around $40 per ton. This year, though, they still averaged above $110 per ton, according to HSBC analysts, and are now around the highest in six months. That’s partly due to hopes Beijing will spend money to stimulate the economy, and partly because new demand for steel used in electric vehicles, wind farms, and other infrastructure helped soften the blow.
As China transitions to a new economic model, its appetite for green technologies should continue to benefit Latin American countries like Chile – a top copper producer – and Indonesia, which produces more niche metals such as nickel, as well as African countries like the Democratic Republic of Congo, which dominates cobalt mining.
As the Chinese idiom goes, a skinnier camel would still be bigger than a horse. From a commodities perspective, investors who are too focused on China’s loss of economic weight risk overlooking the fact that it remains too big to ignore.