china equity july 2012 metals & mining -...

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

Metals &

Min

ing

By Simon Francis and team

We forecast a return to normalized demand growth and prices. Commodities markets are nottight enough to drive up prices, though downside risks are largely cost-curve limited. We

believe China is roughly a decade away from peak consumption levels

Stock valuations are at trough levels. Commodities prices should recover somewhat in 2H12although risks to demand remain. We see the investment opportunities as being poor in steel

and aluminium, better in copper, thermal and metallurgical coal, and good in gold

We initiate/resume coverage of 14 stocks. Our top picks are China Shenhua, Mongolian Mining,Zijin Mining, Shougang Fushan Resources and China Metal Recycling

Disclosures and Disclaimer This report must be read with the disclosures and analystcertifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Ch

ina E

qu

ityJu

ly 2012

Metals & MiningBack to reality – launching coverage in China, Taiwan and Mongolia

Natural Resources & EnergyChina Equity

July 2012

Simon Francis*Head of Metals & Mining Research, Asia PacificThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Simon Francis joined HSBC as Regional Sector Head of Metals & Mining in March 2012. He is a Chartered Accountant (UK ACA) witha degree in mathematics from the University of London. Simon’s equity research experience in Asia spans almost 20 years, virtuallyall of it covering the Metals & Mining sector. He has lived in various countries in Asia and worked for various financial institutions.From 2003 to 2012, he was regional sector head at prominent securities firms in Hong Kong, achieving significant recognition in theGreenwich Asia, Greenwich Europe, and Greenwich US surveys.

Thomas Zhu*Analyst, Metals & Mining, Asia PacificThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Thomas Zhu joined HSBC in March 2012 as Metals & Mining Analyst for the Asia-Pacific region. He holds a Master’s degree in Businessfrom Tsinghua University, Beijing. Following completion of a rigorous graduate training programme at a global investment bank,Thomas worked with Simon Francis as a metals analyst from 2009 to 2012.

Amit Pansari, CFA*AnalystHSBC Bank plc+91 80 3001 [email protected]

Amit Pansari joined HSBC in June 2007 as a part of the Metals & Mining Research team. Prior to joining HSBC, he worked as a researchanalyst with a global analytical company and as a business analyst with an Indian fast-moving consumer good company. Amit is aChartered Accountant and a CFA charter holder.

Chris Chen*Analyst, Metals & Mining, Asia PacificThe Hongkong and Shanghai Banking Corporation Limited+852 2822 [email protected]

Chris Chen holds a first class honours degree in accounting and finance from the Hong Kong University of Science & Technology.Before joining HSBC’s Metals & Mining team as Associate Analyst in 2012, she worked for a global assurance, tax and advisoryservices firm as an audit associate and with Simon Francis as a research associate.

120730_50591_China Metals and Mining_F:Normal Cover 2011 7/30/2012 4:11 PM Page 1

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Natural Resources & Energy China Equity July 2012

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Summary We launch coverage of 14 stocks in the China, Mongolia and Taiwan metals and mining space. We argue that commodities markets are entering a period of slower yet more sustainable demand growth driven by industrialization and urbanization. We believe that the drivers of the last upcycle – loose Chinese monetary policy, increasing Western debt, and China’s fiscal stimulus in 2009 – are simply not prevalent today and that the incredible growth rates of 2003-11, are thus a thing of the past. China remains a decade away from peak consumption levels in our view. For much of the past decade or more, China’s development has been focused on the coastal areas. Substantial parts of central and western China remain relatively undeveloped; urbanization levels are still quite low overall. With slower growth, we think the supply-side will more easily be able to keep up with demand. As a result, the chances of extraordinary price outcomes – as seen in the last cycle – are less likely. Commodities prices have been a key driver of share price performance since 2003 and more benign prices may make investing in the sector trickier. Yet, even in an environment of ‘normalized’ prices some companies will make healthy margins through the cycle. Overall, our approach is neither ‘risk on’ nor ‘risk off’. We simply look for fundamentally sound companies with good earnings prospects driven by stronger prices, industry structural changes or volume growth or stocks that are simply undervalued. Our top picks are China Shenhua, Mongolian Mining, Zijin Mining, Shougang Fushan Resources and China Metal Recycling.

To vote for HSBC in Asiamoney 2012 – www.asiamoney.com/survey/takesurvey/en/BP12/ Click here for more information on HSBC’s HK/China Research Team

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Ratings and valuations 8

A return to normalised growth, and prices 17

China economic outlook 30

Aluminium – structural oversupply to persist 33

Copper – fundamentally fine 42

Gold – higher in a time of crisis 47

Steel – likely to stay tough out there 55

Metallurgical coal – supply side issues abating 67

Thermal coal – taking the heat out of the market 74

Company profiles 85 Aluminum Corp of China (Chalco) (2600 HK) 87

Angang Steel (347 HK) 103

Baoshan Iron & Steel (600019 CH) 115

China Coal Energy (1898 HK) 127

China Metal Recycling (773 HK) 141

China Shenhua Energy (1088 HK) 153

China Steel Corp (2002 TT) 167

Jiangxi Copper (358 HK) 179

Maanshan Iron & Steel (323 HK) 195

Mongolian Mining Corp (975 HK) 207

Shougang Fushan Resources (639 HK) 219

Yanzhou Coal (1171 HK) 229

Zhaojin Mining (1818 HK) 247

Zijin Mining (2899 HK) 261

Disclosure appendix 274

Disclaimer 277

Contents

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HSBC Metals & Mining sector valuation summary

Bloomberg HSBC Mkt cap Target Current Potential __________PE ___________ _______EV/EBITDA_______ _____ PB ______ code rating USDbn price price return* 2011 2012e 2013e 2011 2012e 2013e 2011 2012e

Coal China Coal Energy 1898 HK N(V) 14.1 7.48 6.48 19% 7.2 8.2 7.7 3.6 4.0 3.6 0.9 0.8China Shenhua 1088 HK OW 67.9 34.00 27.15 29% 9.7 9.8 9.4 5.2 5.3 4.9 2.0 1.8Shougang Fushan 639 HK OW(V) 1.3 3.00 1.97 61% 4.7 4.9 4.9 1.6 1.4 1.1 0.6 0.5Mongolia Mining 975 HK OW(V) 1.9 7.15 4.03 77% 16.2 10.0 6.5 13.6 8.0 5.5 2.5 2.0Yanzhou Coal 1171 HK N(V) 11.4 12.80 11.10 19% 5.0 7.7 7.8 3.9 5.5 5.5 1.1 1.0 Steel Angang Steel 347 HK N(V) 4.0 4.14 3.49 19% n.a. n.a. 21.7 10.1 8.6 5.7 0.4 0.4Baoshan 600019 CH N 11.3 4.50 4.11 15% 9.8 7.3 11.1 5.4 4.0 5.0 0.7 0.6CH Metal Recycling 773 HK OW(V) 0.8 12.25 5.58 125% 3.4 3.5 3.1 4.8 4.2 3.2 1.0 0.8China Steel 2002 TT UW 13.2 24.75 26.50 -2% 20.3 42.9 25.3 13.7 20.5 16.0 1.4 1.6Maanshan I&S 323 HK N(V) 2.2 1.75 1.49 17% 135.8 n.a. 12.8 5.0 6.5 4.5 0.4 0.4 Non-ferrous metals Chalco 2600 HK UW(V) 10.6 2.50 3.04 -18% 142.3 n.a. 84.2 10.6 15.1 10.3 0.7 0.7Jiangxi Copper 358 HK N(V) 10.0 19.40 16.50 20% 7.1 7.3 8.1 5.9 5.2 4.2 1.2 1.1 Gold Zhaojin Mining 1818 HK OW(V) 3.3 14.30 8.82 66% 12.7 10.2 9.6 8.1 6.9 6.2 3.2 2.7Zijin Mining 2899 HK OW(V) 10.9 3.70 2.29 66% 7.2 6.8 6.4 4.1 4.1 3.7 1.6 1.4

*Potential return equals the percentage difference between the current share price and the target price, plus the forecast dividend yield. Source: Bloomberg, HSBC Note: Priced as of 25 July 2012

HSBC Metals & Mining key financials summary

Bloomberg code

___ Revenue growth __ ____EBITDA margin ____ ____ EPS growth ___ _______ RoE _______ __ Net debt to equity__ Div yield

2012e 2013e 2014e 2012e 2013e 2014e 2012e 2013e 2014e 2012e 2013e 2014e 2012e 2013e 2014e 2012e

Coal China Coal Energy 1898 HK 5% 9% 6% 20% 20% 20% -12% 6% 3% 10% 10% 10% 5% 2% -3% 4%China Shenhua 1088 HK 17% 6% 6% 36% 35% 36% 0% 4% 9% 19% 18% 17% 7% 2% -3% 4%Shougang Fushan 639 HK -5% 4% -2% 51% 49% 47% -6% 2% -7% 11% 10% 9% -25% -28% -30% 9%Mongolia Mining 975 HK 91% 36% 10% 29% 32% 36% 62% 53% 22% 22% 27% 25% 50% 44% 38% 0%Yanzhou Coal 1171 HK 8% 6% 9% 23% 23% 24% -35% 0% 19% 13% 12% 13% 44% 46% 38% 3% Steel Angang Steel 347 HK -4% 6% -2% 7% 9% 11% nm nm 132% -3% 2% 4% 58% 52% 43% 0%Baoshan 600019 CH -12% 0% 1% 14% 10% 12% 35% -35% 40% 9% 6% 8% 32% 25% 14% 6%CH Metal Recycling 773 HK 6% 6% 17% 4% 4% 4% -3% 12% 16% 25% 23% 23% 40% 21% 13% 6%China Steel 2002 TT -8% 6% 1% 12% 14% 17% -53% 70% 20% 3% 6% 7% 54% 52% 45% 5%Maanshan I&S 323 HK -1% 7% -2% 5% 7% 8% -633% nm 93% -1% 3% 5% 73% 67% 59% 0% Non-ferrous metals Chalco 2600 HK 7% 6% 3% 5% 6% 6% -878% nm 104% -4% 1% 2% 133% 133% 132% 0%Jiangxi Copper 358 HK -3% -16% 5% 8% 10% 10% -2% -10% 14% 15% 12% 13% 0% -16% -24% 2% Gold Zhaojin Mining 1818 HK 30% 11% 12% 46% 45% 43% 25% 6% 10% 28% 25% 24% 30% 15% 0% 3%Zijin Mining 2899 HK 16% 2% 7% 24% 26% 27% 6% 7% 16% 22% 21% 21% 14% 8% -4% 4%

Source: Company data, HSBC estimates

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Share price performance (priced at close of 25 July)

Bloomberg Current 52-week 52-week __________ Absolute performance__________ __________ Relative performance__________ code price low high 1W 1M 3M 1 YR 1W 1M 3M 1 YR

Coal China Coal Energy 1898 HK 6.48 6.08 11.66 -2% 3% -24% -44% -1% 5% -9% -18%China Shenhua Energy 1088 HK 27.15 24.15 40.20 -3% 6% -19% -32% -2% 7% -5% -6%Shougang Fushan 639 HK 1.97 1.93 4.77 -1% -12% -24% -58% 0% -11% -9% -32%Mongolia Mining 975 HK 4.03 4.00 9.88 -6% -14% -36% -58% -5% -13% -21% -32%Yanzhou Coal 1171 HK 11.10 11.04 30.90 -2% -8% -32% -62% -2% -7% -17% -37% Steel Angang Steel 347 HK 3.49 3.44 8.49 -13% -17% -34% -58% -13% -16% -20% -32%Baoshan 600019 CH 4.11 4.11 5.82 -2% -6% -18% -29% 0% -2% -7% -8%China Metal Recycling 773 HK 5.58 5.58 10.88 -5% -9% -36% -44% -5% -8% -21% -18%China Steel 2002 TT 26.50 26.50 31.50 -2% -4% -8% -12% 1% -3% -1% 8%Maanshan Iron & Steel 323 HK 1.49 1.44 3.49 -9% -16% -35% -56% -8% -14% -21% -30% Non-ferrous metals Aluminum Corp of China 2600 HK 3.04 2.98 6.83 -1% -5% -19% -51% -1% -3% -4% -25%Jiangxi Copper 358 HK 16.50 11.30 28.45 -5% 0% -9% -40% -4% 1% 6% -14% Gold Zijin Mining 2899 HK 2.29 1.95 4.46 -7% -11% -21% -47% -6% -9% -7% -21%Zhaojin Mining 1818 HK 8.82 8.00 18.70 -9% -11% -23% -41% -8% -9% -8% -15%

Note: Hong Kong shares relative to HSCEI, China Steel relative to Taiex, Baoshan relative to SHCOMP Source: Bloomberg

HSBC commodity price forecasts

____________________ y-o-y_______________ Unit 2010 2011 2012e 2013e 2014e Long run 2010 2011 2012e 2013e 2014e

Coal

Thermal coal

Australia contract (6700kcal/ kg, fob) USD/t 91 122 119 104 100 82 9% 34% -3% -13% -4%Australia spot (6700kcal/ kg, fob) USD/t 99 121 99 99 101 82 37% 22% -18% 0% 2%Shanxi mixed (5500kcal/kg, fob, inc VAT) RMB/t 746 818 712 683 713 540 24% 10% -13% -4% 4%Datong premium (5800kcal/kg fob, inc VAT) RMB/t 789 872 778 745 763 570 25% 10% -11% -4% 2%

Metallurgical coal

Hard coking coal USD/t 191 289 220 228 208 120 11% 51% -24% 3% -9%Semi-soft coking coal USD/t 141 206 151 143 131 76 14% 46% -27% -5% -9%ULV PCI USD/t 163 223 160 166 151 88 26% 37% -28% 3% -9%Fushan No 4, f.o.r (inc VAT) RMB/t 1,482 1,675 1,622 1,644 1,600 1,200 17% 13% -3% 1% -3%Shanxi 1/3 coking (inc VAT) RMB/t 1,322 1,486 1,504 1,512 1,472 1,104 17% 12% 1% 1% -3% Base metals LME aluminium USD/t 2,175 2,401 2,110 2,200 2,400 2,315 30% 10% -12% 4% 9%SHFE aluminium (in VAT) RMB/t 15,847 16,830 16,166 16,826 17,202 16,600 13% 6% -4% 4% 2%LME copper USD/t 7,551 8,821 8,000 7,500 8,000 6,200 47% 17% -9% -6% 7%SHFE copper (VAT) RMB/t 59,044 65,944 58,500 53,791 57,377 44,500 40% 12% -11% -8% 7%LME nickel USD/t 21,838 22,885 18,030 18,500 20,000 18,700 48% 5% -21% 3% 8%LME zinc USD/t 2,163 2,193 2,019 2,205 2,443 1,742 30% 1% -8% 9% 11% Precious metals Gold USD/oz 1,225 1,570 1,760 1,775 1,750 1,500 26% 28% 12% 1% -1%Silver USD/oz 20 35 31 32 28 25 38% 75% -12% 3% -13% Bulks and steel Alumina USD/t 326 360 317 330 360 312 45% 10% -12% 4% 9%Iron ore-fines (Australia) USD/t 112 163 130 135 135 80 61% 45% -20% 4% 0%China HRC (inc VAT) USD/t 558 640 601 625 610 450 17% 15% -6% 4% -2%

Source: Thomson Reuters Datastream, SXCoal, CUSteel, HSBC forecasts

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HSBC metals and mining “six cells”

Bloomberg code Rating Valuation Consensus

Angang 347 HK N(V) TP HKD4.14, Potential return: 19%

0.5x PB. Poor outlook for returns, previous trough points 2012e: bigger loss 2013e: 20% above TP: 22% below.

Baoshan 600019 CH N TP HKD4.50, Potential return: 15%

0.7x PB. Poor outlook for returns, previous trough points 2012e: 12% below 2013e: 29% below TP: 26% below

Chalco 2600 HK UW(V) TP HKD2.50 Potential return: -18%

DCF valuation. Earnings weak and volatile. 2012e: in line 2013e: n.a.: no consensus TP: 19% below

China Coal 1898 HK N(V) TP HKD7.48 Potential return: 19%

50:50 blend of a PE-based valuation of HKD8.18 based on 10.0x 2012e PE, and a DCF valuation of HKD6.78

2012e: 15% below 2013e: 20% below TP: 15% below

China Shenhua 1088 HK OW TP HKD34.00, Potential return: 29%

50:50 blend of a PE-based valuation of HKD33.75 (based on 12x 2012e PE) and a DCF valuation of HKD34.30


China Steel 2002 TT UW TP TWD24.75, Potential return: -2%

1.5x PB. Poor outlook for returns, previous trough points 2012e: 33% below 2013e: 21% below TP: in line

CMR 773 HK OW(V), TP HKD12.25, Potential return: 125%

50:50 blend of a PE-based valuation of HKD9.50 based on 6.0x 2012e PE, and a DCF valuation of HKD15.00

2012e: 6% below 2013e: 18% below TP: 13% above

Jiangxi Copper 358 HK N(V) TP HKD19.40 Potential return: 20%

50:50 blend of a PE-based valuation of HKD18.50 (based on 7.9x 2012e PE) and a DCF valuation of HKD20.30

2012e: in line 2013e: 10% below TP: in line

Maanshan 323 HK N(V) TP HKD1.75, Potential return: 17%

0.4x PB. Poor outlook for returns, previous trough points 2012e: Loss 2013e: 13% below TP: 28% below.

Mongolia Mining 975 HK OW(V) TP HKD7.15 Potential return: 77%

DCF valuation 2012e: 27% below 2013e: 23% below TP: 7% below

Shougang Fushan 639 HK OW(V) TP HKD3.00 Potential return: 61%

50:50 blend of a PE-based valuation of HKD2.70 (based on 6.7x 2012e PE) and a DCF valuation of HKD3.30

2012e: 5% above 2013e: 7% above TP: in line

Yanzhou Coal 1171 HK N(V) TP HKD12.80 Potential return: 19%

50:50 blend of PE-based valuation of HKD13.25 (based on 9.0x 2012e PE) and a DCF valuation of HKD12.35.


Zhaojin Mining 1818 HK OW(V) TP HKD14.30 Potential return: 66%

50:50 blend of a PE-based valuation of HKD13.30 (based on 15.0x 2012e PE) and a DCF valuation of HKD15.20.


Zijin Mining 2899 HK OW(V) TP HKD3.70 Potential return: 66%

50:50 blend of a PE-based valuation of HKD3.30 (based on 9.5x 2012e PE) and a DCF valuation of HKD4.00.

2012e: 3% below 2013e: 7% below TP: in line

Note: Potential return equals the percentage difference between the current share price and the target price, plus the forecast dividend yield. Source: Bloomberg, HSBC

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HSBC metals and mining “six cells”

Business overview Thesis Potential catalysts

Angang One of China’s largest steel makers with a crude steel capacity of 21.6mtpa

Tough outlook with weak demand, excess capacity and little supply-side discipline. Margins are returns expected to remain suppressed.

Steel and iron ore prices, earnings reports. Potential catalysts could include industry restructuring, upstream integration.

Baoshan One of China’s largest steel makers with a capacity of c26.0mtpa of crude steel

Tough sector outlook. Margins higher than other Chinese producers because of scale, location and niche products, but still under pressure.

Steel and iron ore prices, earnings reports, plant reorganisation. Also, industry restructuring, upstream integration.

Chalco China’s largest producer of aluminium and alumina High cost producer only likely to achieve healthy returns in tight aluminium markets. Restructuring to reduce costs likely to be expensive and long-winded.

Aluminium, alumina and power prices. Future restructuring to lower costs.

China Coal China’s second largest coal producer with coal resources of 19.6bt based on PRC standards

With a high proportion of spot market sales and weaker coal prices, China Coal faces a tougher outlook this year.

Chinese thermal coal prices and the spot-contract sales split. Volume growth through asset injections or greenfield projects.

China Shenhua China’s largest coal producer with c9.3bn tonnes of marketable reserves under JORC standard

The group’s blend of coal and power businesses makes earnings relatively insulated from the current weakness in coal prices

Chinese thermal coal prices and the spot-contract sales split. Expansion of the coal and power businesses.

China Steel Taiwan’s largest steel maker with a controlled crude steel capacity of 13.4m tpa

Competition from China and a lack of raw materials integration has forced down margins and the dividend yield

Steel and iron ore prices, earnings reports. Expansion at Dragon Steel.

CMR China’s largest metals recycling company Strong growth prospects driven by consolidation of the Chinese scrap industry and increasing scrap penetration rates

Higher rates of scrap usage in China. Industry consolidation, improving margins once sufficient market share is gained

Jiangxi Copper China’s largest copper producer Biggest beneficiary of higher copper prices in 2H12e, though upside to copper prices looks limited

Higher copper prices. Greater visibility on projects in Afghanistan and Peru

Maanshan One of China’s leading steel makers with a crude steel capacity of c19mtpa.

Tough outlook with weak demand, excess capacity and little supply-side discipline. Margins are returns expected to remain suppressed.

Steel and iron ore prices, earnings reports. Potential catalysts could include industry restructuring, upstream integration.

Mongolia Mining Coking coal miner in Mongolia, substantial exporter to China

Excellent growth prospects as mines ramp-up. Rapid EPS growth over next two years.

Coking coal prices, development of infrastructure to reduce transportation costs, mine volume growth.

Shougang Fushan China’s second largest producer of hard coking coal Stable output of high quality coal means strong cash flows and a high dividend yield. Little to no immediate growth prospects.

Coking coal prices, potential acquisitions and the approval of the Lianshan Project.

Yanzhou Coal A significant coal miner with operations in China and Australia

Aiming to increase capacity to 150m tpa by 2015. Expansion is ‘back-end loaded’ meaning little contribution to earnings in next two years.

Chinese and international thermal and coking coal prices. Development of new projects, potential acquisitions.

Zhaojin Mining China’s fourth largest gold producer Biggest beneficiary of higher gold prices in 2H12e with excellent resources growth prospects and a forecast gold volume CAGR of c12% in 2011-2014e

Gold prices. Resources growth through acquisitions or exploration

Zijin Mining China’s largest gold producer and second-largest mined copper producer

Beneficiary of higher gold and copper prices in 2H12e and copper volume CAGR of c21% in 2011-14e. Re-rating expected once Zijinshan resumes in 2H12.

Gold and copper prices, the resumption of mining at Zijinshan and potential future acquisitions.

Source: HSBC

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Stock ratings Our most bullish call is on gold

We initiate or re-initiate coverage of 14 stocks in

the metals and mining sector.

We argue that slower economic growth in China

and China’s gradual shift away from fixed asset

investment led growth will lead to a ‘normalising’

of commodities demand growth. We believe the

supply side will be better able to meet this slower

demand growth and that, as a result, we are less

likely to witness the sometimes extraordinary

commodities price outcomes that we saw in the

last upcycle.

Most commodities prices are already returning

towards the top end of the cost curve.

For many metals and mining companies, the

underlying commodity prices have been a key

driver over the past decade. From that perspective,

our forecasts that price outcomes will be more

benign than in the last upcycle makes investing in

the sector trickier.

There is a great expectation that demand growth

in China will accelerate in 2H12 (and certainly

2H12 is expected to look a lot better in y-o-y

terms because 2H11 was so weak) but we

question how significantly this will drive up

prices in well-supplied commodities markets.

Comparing current prices with our average price

forecasts for 2H12, our most bullish call is on

gold which is trading 17% below our forecast for

2H12e. For most other commodities, we expect

average prices in 2H12 to be within 10% of

current prices.

Across the 14 stocks in our universe, our 2012e

earnings forecasts range from being 5% above

consensus to 33% below consensus and we

forecast bigger losses than consensus for the

Chinese steel companies. Our forecasts suggest

the sector is due for another round of earnings

downgrades, probably once the interim results are

released in August.

We see the biggest risks to earnings as being in

the Chinese steel companies (where some analysts

still forecast healthy profits in 2012e) and in

China Steel (UW). We also see downgrades risks

Simon Francis* Head of Metals & Mining Research, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6620 [email protected]

Thomas Zhu* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4325 [email protected]

Chris Chen* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4277 [email protected]

Amit Pansari* Analyst HSBC Bank plc +91 80 3001 3760 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

Ratings and valuations

Valuations are once again at trough levels. Commodities prices

should recover somewhat in 2H12 but risks to demand remain

We see the investment opportunities as being poor in steel and

aluminium, better in copper, thermal and metallurgical coal, and

good in gold

Our top picks are China Shenhua, Mongolian Mining, Fushan

Resources, Zijin Mining and China Metal Recycling

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in some of the coal companies – Mongolian

Mining (OW(V)), China Coal (N(V)) and

Yanzhou Coal (N(V)) – where selling prices have

come off sharply and analysts have yet to fully

adjust forecasts.

Even so, we do think that valuations look cheap.

Most of the stocks we cover are now back to the

trough levels reached in October 2008 and again

in October 2011. It is difficult to conclude, we

think, that prospects in the sector are worse now

than they seemed at those times.

Our valuation approach

Generally speaking we value mining stocks using a

blend of PE and DCF valuations aiming to capture

both the short-term outlook as well as the long-term

value. We tend to use relatively recent trading

histories as a guide for target PE multiples simply

because the macro conditions that drove the sector

in the last upcycle (2003-2008) – ie loose monetary

policy in China and the accumulation of Western

consumer debt – no longer exist.

Where mining operations are starting up there is

usually a period of very rapid growth in

production yet earnings remain low. Multiples are

high because investors are paying for future rather

than present earnings. In these cases – eg

Mongolia Mining – we rely on DCF valuations.

We value the steel companies using PB valuations

because earnings are weak and difficult to forecast.

Our target PB multiples are based on expected

ROEs and relatively recent trading histories.

Overall, the focus of our stock recommendations

is neither ‘risk-on’ nor ‘risk-off’. We look for

fundamentally sound companies with good

earnings prospects driven either by stronger

commodities prices (gold), strong volume growth

or industry structural changes (recycling) or

stocks that are simply undervalued.

Our top picks are…

China Metal Recycling (347 HK, OW(V)) –

industry restructuring, volume growth

China Shenhua (1088 HK, OW) – excellent

long-run growth prospects

Mongolia Mining (975 HK, OW(V)) –

strong volume growth over next two years,

most rapid EPS growth in that period

Shougang Fushan Resources (639 HK,

OW(V)) – dividend yield

Zijin Mining (2899 HK, OW(V)) – exposure

to gold, corporate image recovery, volume

growth

Steelmakers face a period of low margins and poor returns

Chinese steel companies face a difficult

environment characterised by slower demand

growth, surplus capacity, a lack of supply-side

discipline and consequently poor margins and

returns.

While the outlook for 2H12 maybe for better

growth in y-o-y terms, this reflects the weaker

2H11 base, rather than strong underlying demand.

Steelmakers are simply not in a position to force

up prices – which will continue to be ‘cost-push,

rather than ‘demand-pull’ – nor margins.

The de-rating of the steel stocks, especially since

iron ore prices were ‘floated’ in April 2010, is

entirely justified in our view by weaker ROEs.

ROEs are expected to remain weak over the next

few years.

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PB for Angang, Maanshan, Baoshan and China Steel

0.5

1.0

1.5

2.0

2.5

3.0

2003

2004

2005

2006

2007

2008

2009

2010

2011

Maanshan AngangBaoshan China Steel

Source: Company data, HSBC

ROEs for Angang, Maanshan, Baoshan and China Steel

-10%

0%

10%

20%

30%

40%

2003

2004

2005

2006

2007

2008

2009

2010

2011

Maanshan Angang

Baoshan China Steel


Generally speaking we think suppliers of steel raw

materials – steel scrap, coking coal and iron ore –

look better placed than the steel companies.

These companies have better earnings

prospects and greater visibility and some trade at

attractive valuations.

China Metal Recycling is one of our Top Pick

The recycling industry is important because

recycling is significantly more energy efficient than

mining and processing ores. The Chinese

government has started to restructure the industry,

and over the next few years we expect smaller

‘mom and pop’ type businesses to be squeezed out.

Environmental regulations will become stricter and

this will favour larger, more efficient businesses

with proper scrap handling facilities. We believe

that large enterprises such as China Metal

Recycling are likely to emerge with both more

assured growth prospects and better margins.

China Metal Recycling, sales volume

0

1000

2000

3000

4000

5000

2009 2010 2011E 2012E 2013E 2014E

Tonnes

000s

Steel scrap Non-ferrous scrap


China Metal Recycling share prices vs copper prices

R2 = 0.4328

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

6,000 7,000 8,000 9,000 10,000 11,000

LME copper prices, US$/t

Chi

na M

etal

Rec

yclin

g, H

K$

Source: Bloomberg, HSBC

Coking coal – great growth in Mongolia

Mongolian Mining (OW(V)) is another Top Pick

The company offers the fastest EPS growth in our

universe over the next two years (up 62% in

2012e and 53% in 2013e) driven by the ramp up

in production at its Ukhaa Khudag (UHG) mine

and initial production output at Baruun Naran.

The Mongolian government’s approval of the

railway project bodes well for cheaper

transportation costs in the future.

We also rate Shougang Fushan Resources

OW(V), though for entirely different reasons

Fushan is cashed-up – holding roughly half its

market capitalisation in cash – and has poor

11


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growth prospects. The much hoped-for Lianshan

mining project seems to be a pipe-dream to us and

management is now looking for overseas

acquisitions. This means the cash pile is unlikely

to be returned wholesale to shareholders. Despite

this, the combination of a sell-off in the shares

and a c45% payout ratio means the stock is

expected to yield c9% pa in the next three years.

Fushan is by far the highest dividend yielding

stocks in our universe.

Fushan’s annual dividend yields

2%

3%

4%

5%

6%

7%

8%

9%

10%

2009

2010

2011

2012

E

2013

E

2014

E

Source: Bloomberg, company data, HSBC

Thermal coal – anaemic near-term outlook, yet excellent long-run growth

Chinese and international coal prices declined

sharply from April to July 2012, though they are

now stabilising. As a result, earnings will be

weaker than generally expected earlier in the year.

We forecast China Coal’s earnings to decline by

12% y-o-y in 2012e and Yanzhou Coal’s earnings

to decline by 35% y-o-y. Shenhua looks relatively

resilient by virtue of its substantial power business.

The decline in coal prices has led to shares being

sold-off aggressively with valuations now trading

close to their October 2008 and October 2011 trough

levels. This, combined with the fact we expect coal

prices to recover somewhat through 2H12e suggests

that further valuation downside is limited.

All three stocks are focussed on volume growth,

though much of this is ‘back-end loaded’ with

plans to bring on new mines by the end of the

12th Five Year Plan – ie by 2015. This probably

means there is upside potential to our DCF

valuations, but this will not help earnings in the

near term.

China Shenhua (OW) looks cheap to us

We see the most value in China Shenhua, our only

Overweight rating amongst the three stocks.

Shenhua is a low beta stock; it is the most

defensive stock within our coverage universe.

Despite the current uncertain macro environment,

earnings visibility remains relatively high mainly

because of the power business. As a result, we see

the least risk of consensus earnings downgrades

for Shenhua after the 1H12 results. We view the

current sell-off as a buying opportunity.

Consensus earnings downgrade y-t-d (1 Jan 2012 = 100)

80

90

100

110

120

Jan-

12

Feb-

12

Mar

-12

Apr-1

2

May

-12

Jun-

12

Jul-1

2

Shenhua China Coal Yanzhou Coal

Source: Thomson Reuters Datastream, HSBC

Neutral and Underweight base metals, but…

Copper rebound in 2H12e to be restricted by

high Chinese inventories – we rate Jiangxi

Copper Neutral (V)

While we expect copper prices to rise from the

current level in 2H12e, we think the upside will

be limited by high copper inventories in China. In

short, we would need to see a stronger-than-

expected recovery in demand from key

downstream sectors or lower copper inventories to

revisit our forecasts and recommendation.

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Jiangxi Copper (N(V)) offers the highest earnings

leverage to copper among major Chinese

companies. For a 10% increase in copper prices,

we expect Jiangxi Copper’s earnings will increase

by c13% in 2012e and 2013e.

The company does plan to increase its copper

concentrates self-sufficiency ratio, from 21% in

2011 to 40% by 2016e, by increasing output in

Afghanistan and Peru and through further

acquisitions. We have not factored these

projects into our model; greater visibility on the

timing and cost of these assets could also make us

more positive.

Jiangxi Copper share price vs copper prices, 2010-present

R2 = 0.8469

10.00

15.00

20.00

25.00

30.00

6,000 7,000 8,000 9,000 10,000China spot copper prices, US$/t

Jian

gxi C

oppe

r, H

K$/

shr


Aluminium looks structurally challenged

Although we see reasonable aluminium demand

growth, there is plenty of supply, lots of planned

capacity and high inventories. These factors will

keep aluminium prices in check, in our view.

We initiate on Aluminum Corp of China (Chalco)

with an Underweight (V) rating. In our view,

Chalco lacks the level of vertical integration

necessary to achieve meaningful returns in

anything other than tight aluminium markets.

Management is trying to restructure the business

to lower costs but this is like to be a lengthy and

expensive process. Realising that the outlook in

aluminium is weak, Chalco moved into trading in

2010 and into coal in 2012.

We do forecast aluminium prices to rise in 2H12e

and perhaps there is a risk that Chalco shares rise

with aluminium prices. We would sell into a rally

given the poor outlook for earnings and returns.

More positive on gold

Gold producers should benefit from higher

gold prices

James Steel, our gold commodities analyst,

believes that a combination of monetary and

financial influences, geopolitical concerns, and

heightened investor anxiety will spur gold prices

to move above USD1,900/oz by the end of 2012.

This implies more than 20% upside from the

current level.

Zijin Mining (OW(V)) is one of our Top Picks

We like Zijin for three main reasons. First, we

have a positive view on gold and Zijin’s earnings

are sensitive to gold prices. Second, the company

offers robust mined copper volume CAGR of

c21% in 2011-14e. Third, we think the stock

should be re-rated following the recent conclusion

of the CSRC investigation and the Zijinshan

copper mine resumption in 2H12e. Management

is planning a reverse roadshow to the Zijinshan

copper mine in 2H12e. We think this will be a

catalyst for the re-rating.

We also rate Zhaojin Mining OW(V). Although

the street has greater upside to the consensus

target price for Zhaojin, our preference is for

Zijin. First, Zhaojin accumulated inventories in

1Q12 and as a result, 1Q12 earnings represented

only 10% of the current full year consensus

estimate. We see greater risk of consensus

earnings downgrades for Zhaojin. Second, we

believe Zijin has been more heavily shorted

recently suggesting a greater chance of a ‘short

squeeze’ as the corporate image recovers.

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Daily PE of Zijin

4.0

9.0

14.0

19.0

24.0

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

Daily P/E


Zhaojin Mining is even more highly leveraged

to gold prices

Zhaojin offers the highest earnings leverage to

gold among major Chinese companies with

earnings 1.6x sensitive to gold prices in both

2012e and 2013e. We also expect to see decent

volume growth with self-produced gold volumes

expected to rise by a CAGR of c12% in 2011-14e.

Further acquisitions are another potential share

price catalyst.

Zhaojin earnings sensitivity to gold prices in 2012e

Gold prices, USD/oz 1,426 1,584 1,760 1,936 2,130

Net income, RMBm 1,453 1,754 2,089 2,424 2,793

Source: HSBC

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Commodities prices outlook for 2H12 Our sense is that our commodity price forecasts

give somewhat contradictory signals for metals

and mining stocks in 2H12.

On a positive note, we do expect most commodity

prices to rebound from currently weak levels in

2H12 as economic activity recovers.

We are most bullish on gold, where James Steel,

our gold commodity analyst, expects gold prices

to rise above USD1,900/oz by year end, indicating

more than c20% upside from the current level and

c17% upside from current levels to our forecast

for the 2H12 average price.

We also see smaller rebounds in base metals,

thermal coal and Chinese hot-rolled coil (HRC)

prices. Copper should benefit from further power

grid investment and a recovery in white goods

sales. Thermal coal prices should be driven by the

seasonally strong demand in 4Q12e.

These rebounds in prices are already incorporated

into our earnings models.

The risks are two-fold. First, in h-o-h and y-o-y

terms, commodities prices in 2H12e are expected

to be much weaker. This will be apparent in

company earnings; we are set for a series of weak

comparables and another round of downgrades

after the August reporting season.

The second risk is that economic growth in 2H12

may be slower than expected. In that case

commodities prices may not rise as much as we

forecast, with negative implications for earnings.

Commodities prices forecasts (priced as of 25 July 2012)

Unit Now FY12e 1H12 2H12e h-o-h y-o-y 2H upside

from Now

Coal Thermal Coal Australia Spot (6700kcal/ kg, fob) USD/t 81 99 103 95 -8% -19% 17% Shanxi Mixed (5500kcal/kg, fob, inc VAT) RMB/t 620 712 776 648 -16% -23% 5% Datong Premium (5800kcal/kg fob, inc VAT) RMB/t 705 778 830 726 -13% -19% 3% Metallurgical Coal Hard Coking Coal USD/t 225 220 223 217 -3% -28% -4% Semi-soft Coking Coal USD/t 147 151 163 139 -15% -29% -5% ULV PCI USD/t 164 160 162 158 -2% -28% -4% Base metals LME Aluminium USD/t 1,840 2,110 2,084 2,136 2% -5% 16% SHFE Aluminium (inc VAT) RMB/t 15,340 16,166 15,972 16,360 2% -3% 7% LME Copper USD/t 7,440 8,000 8,097 7,903 -2% -4% 6% SHFE Copper (inc VAT) RMB/t 54,330 58,500 58,065 58,935 1% -4% 8% LME Nickel USD/t 15,825 18,030 18,430 17,630 -4% -13% 11% LME Zinc USD/t 1,792 2,019 1,984 2,054 4% -1% 15% Precious Metals Gold USD/oz 1,601 1,760 1,649 1,871 13% 11% 17% Silver USD/oz 27 31 31 31 0% -12% 14% Bulks and Steel Alumina USD/t 325 317 312 322 3% -4% -1% Iron Ore-Fines (Australia fob) USD/t 111 130 133 127 -5% -16% 15% China HRC (ex VAT) USD/t 554 601 597 605 1% -4% 9%

Source: Bloomberg, Brook Hunt, SXCoal, HSBC

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Stocks are back to trough valuations Given the recent sell-off in commodities, we

examine which stocks are trading at or close to

previous trough valuations. We use PB valuations,

as earnings in the sector are largely driven by

commodity prices which are volatile, even at the

best of times. We look at two trough periods; the

Euro crisis in October 2011 and the global financial

crisis in October 2008. We look at both the

absolute trough points and also a 20-day period

average around the trough in order to remove one-

day share price anomalies. (We exclude Mongolian

Mining from this analysis because the stock was

only listed in October 2010).

We calculate that all stocks except Jiangxi Copper

are currently trading below the 20-day average

trough valuation in October 2011. Actually all

stocks except Jiangxi Copper and Zijin Mining are

trading at or below the absolute trough reached in

October 2011.

When compared with 2008 troughs, 7 stocks –

China Coal, Shougang Fushan, Angang,

Maanshan, Baosteel, Chalco and Zijin – are

trading at a 10% premium or less to the 20-day

average trough valuation with Baoshan and Zijin

trading below the absolute trough point.

We think it is hard to conclude that prospects in

the sector are worse now than they seemed at

these trough points, suggesting to us that stock

prices already factor in the weak commodities

prices outlook.

Metals and mining PB multiples - now versus 2008 and 2011 troughs (based on daily one-year forward valuations)

_____________________ 2008 trough______________________ _____________________ 2011 trough______________________ Now Trough 20 days

average Downside to

troughDownside to 20

days averageTrough 20 days

average Downside to

troughDownside to 20

days average

Coal China Coal 0.78 0.54 0.84 -31% 8% 0.83 0.97 7% 25%China Shenhua 1.65 0.89 1.46 -46% -11% 1.82 2.08 10% 26%Yanzhou 0.93 0.46 0.68 -51% -27% 1.24 1.56 33% 67%Fushan 0.48 0.41 0.51 -15% 6% 0.53 0.71 10% 46% Steel Angang 0.42 0.35 0.53 -16% 27% 0.42 0.53 0% 26%Maanshan 0.35 0.25 0.37 -29% 6% 0.35 0.42 1% 20%Baoshan 0.63 0.80 0.92 27% 46% 0.79 0.82 26% 30%China Steel 1.57 0.96 1.13 -39% -28% 1.67 1.70 6% 8%CMR 0.73 n.a. n.a. n.a. n.a. 0.90 1.12 23% 54% Non-ferrous Chalco 0.67 0.51 0.71 -25% 5% 0.74 0.82 10% 21%Jiangxi Copper 1.00 0.34 0.50 -66% -50% 0.70 0.90 -30% -10% Gold Zhaojin 2.30 0.61 0.84 -73% -63% 3.00 3.50 30% 52%Zijin 1.20 1.30 1.90 8% 58% 1.10 1.40 -8% 17%

Source: Company data, Datastream, HSBC

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HSBC vs consensus Our earnings forecasts for 2012e range from being

5% above to 33% below consensus for most

stocks and we forecast larger losses than

consensus for the steel companies. Given the

weakness in commodities prices recently – most

notably in thermal coal – we would expect to see

a round of earnings downgrades once the interim

results are released.

Over the past one month, most company earnings

were downgraded by 1% to 425% with share

prices down by 3% to 17%. China Shenhua and

China Coal shares actually rose by 1% to 3%

despite the earnings downgrades, probably

suggesting that the market expects further

earnings downside to be limited for these stocks.

Over the past three months, earnings have been

downgraded for most stocks (by 3% to 391%)

with share prices down by 6% to 36%. Only

Baosteel had earnings upgraded by 17%, though

the share price has still declined by 16%.

Consensus earnings changes vs. share price changes over last one month

-40%-35%-30%-25%-20%-15%-10%-5%0%5%

10%

Anga

ng

Baos

teel

Cha

lco

Chin

a co

al

CM

R

CSC

Fush

an

JXC

Maa

nsha

n

MM

C

Shen

hua

Yanz

hou

Zhao

jin Zijin

Earnings change Price Change

-164%-425% -49%


Consensus earnings changes vs. share price changes over last three month

-60%-50%

-40%-30%

-20%-10%

0%10%

20%

Anga

ng

Baos

teel

Cha

lco

Chin

a co

al

CM

R

CSC

Fush

an

JXC

Maa

nsha

n

MM

C

Shen

hua

Yanz

hou

Zhao

jin

Zijin

Earnings change Price Change

-212% -391% -77%


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A period of sustained, but slower growth In this section we outline our big picture view of the

commodities markets. We also compare China to

other Asian economies to try and assess when

China’s commodities demand may mature. We

argue that markets are entering a period of slower,

yet more sustainable, growth driven by the

traditional forces of industrialisation and

urbanisation. We believe that the incredible demand

growth rates seen in 2003-2011 are a thing of the

past. With slower growth, we think the supply side

will much more easily be able to keep up with

demand. As a result, we view the chances of

extraordinary price outcomes – as seen in the last

upcycle – as much less likely.

China’s role in all of this is vitally important.

China represents typically 40-55% of global

demand for commodities, and often 40-100% of

annual incremental demand. Slowing Chinese

GDP growth and the government’s gradual shift

away from a fixed asset investment led economy

will have an important bearing on commodities.

Last upcycle drivers

We believe the commodities upcycle of 2003-08 –

a period when supply struggled to keep up with

demand and prices reached record highs – was

driven by surging private sector debt in the US

and loose Chinese monetary policy. Private sector

debt in the US rose from 183% of GDP in 2003 to

a peak of 214% in 2007. Chinese M2 growth

average c18% during the period.

After the financial crisis in 2008, the cycle was

further extended by the Chinese governments’

RMB4trn fiscal stimulus. Notably, Chinese M2

growth shot up to 30% in November 2009.

Over the next few years, we expect a return to

normalised growth rates, without the drivers of

debt accumulation in the West, loose monetary

policy in China or the massive fiscal stimulus

provided by China from 2009. We also expect

China to continue to develop its economy towards

consumption, gradually departing from its historical

model of growth led by fixed asset investment.

A return to normalised growth, and prices

We forecast a period of sustained yet slower demand growth;

China remains a decade away from peak consumption levels

Commodities markets are not tight enough to drive up prices

though downside risks are largely cost-curve limited

We forecast relatively benign commodity price outcomes

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Commodity cycle drivers and role of China US private sector debt as a % of GDP China M2 growth (y-o-y)

180%

190%

200%

210%

220%

2003

2004

2005

2006

2007

2008

2009

2010

2011

10%

15%

20%

25%

30%

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

Source: World Bank, HSBC Source: Bloomberg, HSBC

China share of global commodities demand China share of commodity demand growth (2007 to 2011)

0%

10%

20%

30%

40%

50%

60%

Aluminium Copper Iron ore Steel Coal

2007 2011

107%

209%

103%124%

98%

0%

50%

100%

150%

200%

250%


Source: Brook Hunt, World Steel Association, BP, HSBC Source: Brook Hunt, World Steel Association, BP, HSBC

China commodity demand growth (CAGR) Global commodity demand growth (CAGR)

0%

5%

10%

15%

20%

25%

30%

2003-2007 2007-2011 2011-2015e

Alum inium Copper Iron oreSteel Coal

0%

2%

4%

6%

8%

10%

2003-2007 2007-2011 2011-2015e

Alum inium Copper Iron oreSteel Coal

Source: Brook Hunt, World Steel Association, HSBC Source: Brook Hunt, World Steel Association, BP, HSBC

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Estimating the point of economic ‘take-off’

The starting point for our analysis is an estimate

of the point of ‘take-off’ for each economy. That

is the level of income per capita at which

materials consumption starts to accelerate. In

Asia, we find this is around GDP levels of

USD2,500/capita measured in constant 1990

dollars. We take these ‘take-off’ points as 1952

for Japan, 1970 for Taiwan, 1972 for Korea and

1999 for China.

We accept this is not an exact science.

Consumption patterns are driven by various

factors including income levels, savings rates,

building habits, geology, topology, the availability

of credit, tax rates and others, and thus may differ

across different economies.

Is 1970 too early for Taiwan? We don’t think so.

GDP per capita reached USD2,500 (1990 dollars)

in 1970 and steel consumption per capita rose by

3.6x in the following four years.

China has seen phenomenal demand growth…

Metals consumption in China has grown rapidly in

the years since economic ‘take-off’. In fact,

demand growth in China has been much faster than

in other Asian economies at similar stages of their

development. For instance, our analysis of steel

demand per capita suggests that, ten years after

‘take-off’, Chinese cumulative consumption was

1.7x that of Japan and 1.6x that of South Korea.

Average GDP per capita for each five year period (1990 constant USD) and cumulative steel demand per capita for each five year period (tonnes)

_____________ Japan _____________ _____________ China_____________ ____________ S Korea ____________ _____________Taiwan ____________ GDP/capita y-o-y Steel/capita y-o-y GDP/capita y-o-y Steel/capita y-o-y GDP/capita y-o-y Steel/capita y-o-y GDP/capita y-o-y Steel/capita y-o-y

1950-54 2,288 0.31 400 934 1,025 55-59 3,139 37% 0.59 89% 496 1,200 28% 1,254 22% 60-64 4,797 53% 1.25 113% 464 1,285 7% 1,487 19% 65-69 7,290 52% 2.18 74% 548 1,700 32% 2,063 39% 70-74 10,613 46% 3.26 49% 626 0.15 2,559 50% 0.33 3,065 49% 0.4675-79 12,165 15% 2.74 -16% 717 15% 0.18 26% 3,754 47% 0.77 136% 4,278 40% 1.05 127%80-84 14,068 16% 3.00 10% 930 30% 0.23 23% 4,671 24% 1.01 31% 5,768 35% 1.52 45%85-89 16,478 17% 3.24 8% 1,318 42% 0.31 39% 6,899 48% 1.71 70% 8,255 43% 2.47 62%90-94 19,311 17% 3.54 9% 1,671 27% 0.40 26% 9,924 44% 2.89 69% 11,307 37% 4.94 100%95-99 20,196 5% 3.14 -11% 2,310 38% 0.47 18% 12,996 31% 3.82 32% 14,615 29% 5.45 10%2000-04 20,824 3% 3.02 -4% 3,318 44% 0.82 75% 16,289 25% 4.63 21% 17,205 18% 5.35 -2%05-09 22,195 7% 3.08 2% 5,617 69% 1.67 104% 19,658 21% 5.50 19% 20,810 21% 4.49 -16%

Source: Conference Board Total Economy Database, World Steel Association, HSBC

Steel demand per capita (kg) took off when per capita income levels reached USD2,500

0

100

200

300

400

2,000 3,000 4,000 5,000 6,000 7,000

Japan S Korea Taiw an China

Source: World Steel Association, HSBC

Cumulative steel demand per capita (tonnes)

2. 1

3.5

1.5

2.3

1. 2

2.0

1.3

1.9

0.0

1.0

2.0

3.0

4.0

10 y rs from take off 13 y rs from take off

China Taiwan Japan S. Korea

Source: World Steel Association, HSBC

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…driven by rapid GDP growth and high metal intensity

Income levels in China have grown more quickly

than in other Asian nations in the period following

‘take-off’. Whereas in Japan, South Korea and

Taiwan it took 17-18 years for GDP per capita to

rise from cUSD2,500 to cUSD8,000, in China this

growth took just 13 years.

GDP per capita from take off year (1990 constant USD)

2,000

4,000

6,000

8,000

10,000

12,000

1 3 5 7 9 11 13 15 17 19

Japan Taiw an S Korea China

Source: The Conference Board Total Economy Database, HSBC

Further, China’s economic growth has been more

metals intensive. That is, China has consumed more

metal per unit of GDP than Japan, South Korea or

Taiwan. We attribute this to the high proportion of

fixed asset investment in Chinese GDP.

China Urban FAI as a % of nominal GDP

0%

10%

20%

30%

40%

50%

60%

70%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: Thomson Reuters Datastream, CEIC, HSBC

We estimate that in 1999 to 2007, the 8 years after

economic take-off, China consumed an average of

5.2 tonnes of steel per million dollars of GDP

(again based on constant 1990 dollars). This

consumption level is far higher than the other

Asian nations we have examined where steel

intensity was typically c2 tonnes per million

dollars of GDP at take-off and averaged c4 tonnes

over the next decade.

We see a similar trend in aluminium. China’s

average aluminium consumption per million

dollars of GDP was 114 kg in 1999 to 2007. This

compares to an average of Japan, South Korea and

Taiwan of 55 kg.

For both steel and aluminium, China has had ready

access to the key raw materials – iron ore and coking

coal for steel and bauxite/alumina for aluminium –

and has had no issues raising consumption. The

trend is slightly different for copper.

In copper, China’s consumption has grown

broadly in line with the patterns seen in other

countries, except perhaps in 2006-07 when

Chinese consumption seemed low. We attribute

this to incredibly high prices at the time. China is

short of copper – copper imports in the form of

concentrates and scrap represent a substantial

portion of total demand – and the demand trend is

slightly different as a result.

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Higher GDP growth and metal intensity has led to higher per capita metals consumption

Steel consumption per unit of GDP from take-off year (tonnes per USDm)

Steel consumption per capita from take-off year

0.0

2.0

4.0

6.0

8.0

1 3 5 7 9 11 13 15 17 19

Japan Taiw an S KoreaChina Forecast

0

200

400

600

800

1 3 5 7 9 11 13 15 17 19

Year from take off

Stee

l/cap

ita (k

g)

China Japan S. Korea Taiw an

Source: The Conference Board Total Economy Database, World Steel Association, HSBC Source: World Steel Association, HSBC

Aluminium consumption per unit of GDP from take-off year (kg per USDm)

Aluminium consumption per capita from take-off year

0

50

100

150

200

1 3 5 7 9 11 13 15 17 19


0

5

10

15

1 3 5 7 9 11 13 15 17 19Year from take off

Alu

min

ium

/ cap

ita (k

g)


Source: The Conference Board Total Economy Database, Brook Hunt, HSBC Source: Brook Hunt, HSBC

Copper consumption per unit of GDP from take-off year (kg per USDm)

Copper consumption per capita from take-off year

0

50

100

150

200

1 3 5 7 9 11 13 15 17 19


0

5

10

15

20

1 3 5 7 9 11 13 15 17 19Year from take off

Cop

per/

cap

ita (k

g)


Source: The Conference Board Total Economy Database, Brook Hunt, HSBC Source: Brook Hunt, HSBC

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Unwinding of these factors will likely lead to slower demand growth

We forecast slower demand growth across the

commodities spectrum than we saw over the past

decade with a notable slow down in Chinese

growth rates.

Firstly, we expect slower Chinese real GDP

growth. Chinese real GDP grew at an average of

10.5% p.a. in 2003 to 2011. Growth slowed to

8.1% in 1Q12 and further to 7.6% in 2Q12. The

HSBC economics team forecasts GDP at 8.4% in

2012e and 8.8% in 2013e, still slower than during

the last upcycle. China has embraced a policy of

slower and more sustainable economic growth

and targets a 7% GDP growth in the 12th Five

Year Plan (2011-2015).

Secondly, we believe that Chinese economic

growth will become less metal intensive as the

government gradually shifts the economy away

from fixed asset investment and towards higher

consumption levels.

These two factors together will lead to slower but

more sustained metals demand growth in China,

in our view. With slower demand growth, China’s

contribution to world growth is expected to

decline. We expect Chinese demand growth to

broadly converge with global demand growth

over the next four years.

China real GDP growth (y-o-y) China nominal FAI growth (y-o-y)

8%

9%

10%

11%

12%

13%

14%

15%

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

e

2013

e

18%

20%

22%

24%

26%

28%

30%

32%

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

e

2013

e

Source: CEIC, HSBC Source: CEIC, HSBC

China share of global demand growth China and global commodity demand growth*

107%

209%

103%124%

98%

65%52% 51% 54%

110%

0%

50%

100%

150%

200%

250%


2007-2011 2011-2015e

0%

5%

10%

15%

20%

2003-2007 2007-2011 2011-2015e

China World

Source: Brook Hunt, World Steel Association, BP, HSBC

*Simple averages of aluminium, copper, iron ore, steel and coal CAGR Source: Brook Hunt, World Steel Association, BP, HSBC

23


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How long until China peaks? We often hear the view that China is ‘peaking out’

and that commodities consumption growth is

bound to slow in the near future. We try to

quantify this using the above income and

consumption per capita analysis.

We examine the intensity of materials consumption

in China compared with other countries at similar

stages of development. We conclude that China is

broadly following a development path already

travelled by other Asian nations and is roughly a

decade away from its peak.

While we accept that some areas of China are

maturing in terms of commodities consumption

per capita – eg, Shanghai, Beijing and Tianjin –

most of China is not. Neither the per capita

consumption or income levels, nor the

urbanisation levels suggest to us that consumption

rates are peaking.

Based on the experience of other countries,

commodities consumption levels tend to peak

when GDP reaches USD11,000-13,000 per capita.

Demand then tends to stabilise, though it may

remain at or around peak levels for years to come.

Assuming a real GDP growth rate of 8% until

2015e, and 5% thereafter, and population growth

of 1% p.a., we estimate China will reach this level

of income in 2020-21 – ie, eight to nine years

from now.

This would be consistent with other Asian

economies where peak consumption levels were

reached 21-24 years after take-off.

GDP per capita at peak demand levels (1990 constant USD) Steel consumption per capita vs GDP per capita

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Korea Taiw an Japan

0

500

1,000

1,500

0 5,000 10,000 15,000 20,000 25,000

Incom e per Capita (PPP)

Dem

and

per

Cap

ita (

kg)

China Japan S.Korea Taiw an

Source: The Conference Board Total Economy Database, HSBC Source: World Steel Association, GGDC, HSBC

Aluminium consumption per capita vs GDP per capita Copper consumption per capita vs GDP per capita

0

5

10

15

20

25

30

0 5,000 10,000 15,000 20,000 25,000

Incom e per Capita (PPP)

Dem

and

per C

apita

(kg)


0

510

15

20

25

30

0 5,000 10,000 15,000 20,000 25,000

Income per Capita (PPP)

Dem

and

per C

apita

(kg)


Source: Brook Hunt, GGDC, HSBC Source: Brook Hunt, GGDC, HSBC

24


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Chinese urbanisation levels remain low …

Despite the phenomenal pace of development

over the past few years, China still has a

substantial rural population. We expect to see

urbanisation continue over the next few years.

This is important because urbanisation drives

metals demand.

This analysis that Chinese commodity intensity will

not peak until the early 2020s is consistent with

HSBC’s earlier work in this area. See our global

metals and mining sector report of 20 September

2011, The structural vs. cyclical metals debate: Will

China offset a Western slowdown?

China urban and rural population (m people) China household steel intensity (kg)

Source: Rio Tinto presentation Source: Rio Tinto presentation

Steel intensity increases with urbanization (kg per sq m) Global rural and urban population (bn people)

Source: BHP Billiton presentation Source: BHP Billiton presentation

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ul1fqcg05x&n=308437.PDFhttps://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=ul1fqcg05x&n=308437.PDF

25


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…and western China still has a way to go

Early economic development in China was

focused in the coastal regions. As a result, we

estimate that the western regions are on average

about five years behind the coastal regions in

terms of income per capita. In some provinces, the

difference could be as much as 10 years. These

differences in income levels are a key reason why

the Chinese government has now set about

balancing growth across China by developing

these poorer regions.

Western areas of China five years behind eastern ones

0

10

20

30

40

50

60

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

East (ex cl. Shanghai) West Jiangsu Gansu Guizhou

Real GDP per capita (Rmb'000/person), 2000 price

Source: CEIC, HSBC

China GDP per capita by province (2010 nominal USD)

Source: BHP Billiton presentation

Chinese regional steel intensity (urban population), steel use per capita 2011 (kg)

Source: Rio Tinto presentation; Note: bubble size represents population

26


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Prices normalising too As a result of this slower demand growth, we

expect the supply-side to be more easily able to

match demand, thus reducing the likelihood of

extraordinary price outcomes. We have already

seen some commodities prices returning to the

levels of the top end of the cost curve.

The coal market has been a good testament to this

over the past few months. Better weather in

Australia and Indonesia, the greater availability of

hydro-power in China and the low gas prices in the

US have meant that the coal market is no longer

structurally tight. International coal prices have

collapsed back toward the top of the cost curve.

Limited downside risk to prices given cost support…

We see limited downside to prices given that

commodities are typically closer to the top end of

the cost curve now and also given our expectation

that economic activity will pick-up through the

second half of the year.

Global aluminium 90th percentile cash cost vs. price Global iron ore cost curve

1,000

1,500

2,000

2,500

3,000

3,500

2000

2002

2004

2006

2008

2010

2012

C1

cash

cos

t (U

SD/t)

90th percentile C1 cost LME Aluminium

0

20

40

60

80

100

120

140

0 600 1,200 1,800

Cumulative Costed Production (mt)

C1

cash

cos

t (U

SD/t)

Low Quality Chinese ore

Iron ore spot price USD/t (fob, 62% Fe)

Source: Brook Hunt, HSBC Source: AME, HSBC

Global thermal coal 90th percentile cash cost vs. price Global metallurgical coal 90th percentile cash cost vs. price

Source: Brook Hunt, HSBC Source: Brook Hunt, HSBC

27


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…yet limited upside risks as the markets remain well supplied

We expect commodities markets to remain well

supplied over the medium term. The pinch point

charts highlight that most commodities markets

are far from being tight. This is true for

aluminium, nickel and zinc where market

fundamentals are more relevant. For copper, we

believe that the market remains somewhat tight

compared with historical standards. This, along

with significant investment demand has enabled it

to trade above the cash cost.

Please see our Metals Quarterly for full details of

our price forecasts.

Aluminium price vs stock consumption days Copper price vs stock consumption days

0

1,000

2,000

3,000

4,000

5,000

0 10 20 30 40

Days of inventory

LME

Pric

es (U

SD/t)

All data 1Q00-4Q031Q04-2Q08 2Q12

0

2,000

4,000

6,000

8,000

10,000

0 10 20 30

Days of inventory

LME

Pric

es (U

SD/t)

All data 1Q00-4Q031Q04-2Q08 2Q12

Source: Thomson Reuters Datastream, Brook Hunt, HSBC Source: Thomson Reuters Datastream, Brook Hunt, HSBC

Nickel price vs stock consumption days Zinc price vs stock consumption days

0

20,000

40,000

60,000

0 10 20 30 40

Days of inventor y

LME

Pric

es (U

SD/t)

All data 1Q00-4Q031Q04-2Q08 2Q12

0500

1,0001,500

2,0002,500

3,0003,500

0 20 40 60Days of inventory

LME

Pric

es (U

SD/t)

All data 1Q00-4Q031Q04-2Q08 2Q12

Source: Thomson Reuters Datastream, Brook Hunt, HSBC Source: Thomson Reuters Datastream, Brook Hunt, HSBC

https://www.research.hsbc.com/midas/Res/RDV?ao=20&key=vA74dYVc02&n=335755.PDF

28


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Price outcomes and risk

Short-term prices can be driven by the

perception of risk

Although the markets perception of the level of

risk, as measured by the VIX index is lower than

it was in say October 2011, changes in the

perception of risk will still drive commodities

prices. In particular:

Increasing market risk is generally bad for

commodities prices. Prices can trade below

their ‘fundamental’ level if the risk perception

is high enough.

Relative strength in the US dollar – which is

being seen as a relative safe haven in the

current (mainly Eurozone) crisis – should be

negative for commodities.

Cost support, while valid over the medium

term, did not serve as a fundamental support

level during the 2008-2009 crisis.

Daily VIX & LME 3-month aluminium LME and SHFE 3-month aluminium prices

1,800

2,000

2,200

2,400

2,600

2,800

Jan-

11

Apr-1

1

Jul-1

1

Oct

-11

Jan-

12

Apr-1

2

Jul-1

2

US$

/t

10

20

30

40

50

3-month LME Aluminium VIX (RHS)

1,000

1,500

2,000

2,500

3,000

3,500

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

US$

/t

3-month LME Aluminium SHFE 3m (ex-VAT)

Source: Bloomberg Source: Bloomberg, HSBC

Daily VIX & LME 3-month copper LME and SHFE 3-month copper prices

6,500

7,500

8,500

9,500

10,500

Jan-

11

Apr-1

1

Jul-1

1

Oct

-11

Jan-

12

Apr-1

2

Jul-1

2

US$

/t

10

20

30

40

50

3-month LME copper VIX (RHS)

2,500

4,500

6,500

8,500

10,500

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

US$

/t

LME 3 month SHFE 3 month (ex -VAT)

Source: Bloomberg Source: Bloomberg, HSBC

29


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We expect benign commodity price outcomes

LME Aluminium (USD/t) LME Copper (USD/t)

1,800

2,000

2,200

2,400

2,600

2,800

Dec-

09

Dec-

10

Dec-

11

Dec

-12

Dec

-13

Dec

-14

Spot prices Av erage spotEstimated av erage

6,000

7,000

8,000

9,000

10,000

Dec

-09

Dec-

10

Dec

-11

Dec-

12

Dec

-13

Dec

-14

Spot prices Av erage spotEstimated average

Source: Bloomberg, Thomson Reuters Datastream, HSBC Source: Bloomberg, Thomson Reuters Datastream, HSBC

Thermal Coal spot (Australia export fob, USD/t) Coking Coal contract (Australia export HCC fob, USD/t)

8090

100

110

120

130

140

Dec

-09

Dec

-10

Dec-

11

Dec-

12

Dec-

13

Dec

-14


150

200

250

300

350

Dec

-09

Dec

-10

Dec-

11

Dec-

12

Dec-

13

Dec

-14



Iron ore (China cif, 62% Fe, USD/t) China HRC (including VAT, USD/t)

120

140

160

180

200

Dec

-09

Dec

-10

Dec-

11

Dec-

12

Dec-

13

Dec

-14


500

550

600

650

700

Dec

-09

Dec

-10

Dec-

11

Dec-

12

Dec-

13

Dec

-14



30


abc

China’s economic outlook Reserve requirement ratio (RRR) cuts, two drops

in interest rates, faster approvals for infrastructure

projects, tax incentives to buy energy-efficient

home appliances, lower regulatory barriers for

investment – the list of easing moves goes on and

on. Beijing has clearly started to take more

decisive action to fuel growth in domestic demand

to offset the impact of the global slowdown.

For the rest of the year, we expect another 200bp

of reserve ratio cuts, additional fiscal spending on

public works, tax cuts and tax incentives to buy

consumer goods as well as lower regulatory

barriers for private investment. This strong mix of

monetary, fiscal and regulatory easing, once it

filters through, should lift domestic investment

growth while keeping consumption steady in the

coming quarters. Despite weakening global

demand, our China economist Qu Hongbin

expects China’s growth should recover from 7.8%

in 2Q to over 8.5% in 2H12.

China has slowed…

China has slowed faster than expected, implying

that growth in 2Q may have dropped below

Beijing policy makers’ comfort zone. Industrial

production (IP) growth was close to a three-year

low in June (9.5% y-o-y) and hard numbers such

as electricity production was only flat y-o-y.

Industrial output growth is slowing…

0

5

10

15

20

25

05 06 07 08 09 10 11 12

(%y r,3mma)

40

45

50

55

60

IP (Lhs)HSBC China manufacturing PMI *(Rhs, lead by 2m)

Source: Markit, CEIC, HSBC

The slowdown is likely to have continued into

July, as indicated by the weaker reading of July’s

HSBC flash manufacturing PMI. As the first

available leading indicator, it remained below 50

despite mild m-o-m recovery from the second

lowest level in 39 months.

…but has probably bottomed

Beijing has already started to take more decisive

action to fuel growth in domestic demand to offset

the impact of the global slowdown. It has cut

banks’ required reserve ratios (RRR), announced

two drops in interest rates and is speeding up

approvals for infrastructure projects as well as

China economic outlook

Beijing is stepping up easing on the monetary, fiscal and

regulation fronts

Once this filters through, growth will likely recover to over 8.5%

And there’s still enough fiscal ammunition left to support growth if

the Eurozone recession deepens further

Qu Hongbin Economist The Hongkong and Shanghai Banking Corporation Limited (HK) +852 2822 2025 [email protected]

Sun Junwei China Economist The Hongkong and Shanghai Banking Corporation Limited +86 10 5999 8234 [email protected]

31


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introducing tax incentives to buy energy-efficient

home appliances and lowering regulatory barriers

for investment.

Rate cuts as inflation falls fast

-4

-2

0

2

4

6

8

10

01 02 03 04 05 06 07 08 09 10 11 12

1-y ear lending rate 1-y ear deposit rate

CPI

Source: CEIC, HSBC

Our China economist expects additional monetary

easing, mainly through the use of quantitative

tools (open market operations and an additional

200bp in RRR cuts before year-end). The

possibility of further interest rate cuts is still open

should inflation falls faster than expected.

This strong mix of monetary, fiscal and regulatory

easing, once it filters through, should lift domestic

investment growth while keeping consumption

steady in the coming quarters. Despite weakening

global demand, China’s growth should recover

from 7.8% in 2Q to over 8.5% in 2H12, in our

China economist’s estimation.

Credit easing will likely lift investment growth

15

20

25

30

35

40

05 06 07 08 09 10 11 12

(%y r, 3mma)

10

15

20

25

30

35

40(%y r, 3mma)

Fix ed asset inv estment (Lhs) Loans (Rhs)

Source: CEIC, HSBC

Additional ammunition if needed

Our forecast that growth will be above 8.5% in

2H assumes the Eurozone will have a shallow

recession of around -0.6%, in line with HSBC’s

European economists’ forecast. But what if the

Eurozone slips into a much deeper recession (say

-5% or -6%) and Greece leaves?

Without more aggressive easing, a deep Eurozone

recession would create a real risk that China’s

growth would drop to below 6% in 2H from the

current level of around 7.5% in 2Q, according to

our China economist. That would be too big a risk

for Beijing. Historical experience shows that GDP

growth of below 8% invites the risk of high levels

of unemployment. Social stability is of paramount

importance this year, given that Beijing policy

makers want to secure a smooth leadership change

later this year.

32


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Below 8% GDP growth invites the risk of high levels of unemployment

6

8

10

12

14

05 06 07 08 09 10 11 12

3.9

4.0

4.1

4.2

4.3

4.4

GDP (LHS) Urban unemploy ment rate (RHS)

(%y r) (%)

Source: CEIC, HSBC

We are confident that should things turn really

ugly in the Eurozone, China would still have

enough fiscal ammunition left to support growth

at around 8%. Here are the main options:

A stronger dose of fiscal stimulus: China’s

overall fiscal position remains strong. Apart

from RMB3trn in cash deposits that provide a

strong buffer to a slowdown, Beijing could

issue RMB1-2trn of special infrastructure

bonds to invest mainly in public housing. The

target of building 36m public housing units

during the 12th Five-Year plan (2011-15)

should cover the lowest income group in the

cities. Besides the 10m units begun last year

and another 7m to be started this year

(implying around 20% growth for ongoing

projects), that still leaves nearly 20m units to

be built in the coming three years. Beijing can

front-load the construction, which involves

investment of approximately RMB2,500bn

(or 5.3% of 2011 GDP). This not only

provides a strong cushion against an

investment slowdown in the short term, but

would also boost consumption when the

units are finished and also reduce the

incentives for precautionary savings in the

medium and long term.

Cutting rates by another c70bps to cushion the

investment downturn: As a reference, during

the 2008-09 slowdown China cut interest rates

by 216bps in three months. The current-year

lending rate stands at 6.00% (after the rate

cuts), still higher than the average of 5.84%

over the past decade. The significant negative

output gap should allow more aggressive rate

cuts to bring the benchmark interest rate below

its long-term level.

Opening more sectors to private capital: This

requires little government spending but could

spur investment in the higher added value

service sectors from which private investment

is currently excluded. There are still

restrictions for investing in areas such as

education, financial services and media.

Services sectors: higher value-added (breakdown)

0

0.1

0.2

0.3

0.4

0.5

0.6

Manufacturing Serv ices

Employ ee Compensation Net Tax es

Depreciation Operating Surplus

Source: NBS, HSBC

Cutting taxes more aggressively, especially

for SMEs: The VAT reforms that took place

in 2009 are estimated to have reduced the

corporate tax burden by RMB120bn. If the

VAT pilot scheme in Shanghai is rolled

across the whole nation it is likely to cut taxes

by a further RMB100-150bn.

33


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Prices now at cost support levels London Metal Exchange (LME) aluminium prices

have fallen sharply from their somewhat euphoric

highs of mid-2011 and are now trading well

below the top end of the cost curve. With falling

global demand growth, plenty of supply –

especially from China – and increasing

inventories, it seems unlikely that prices will

rebound significantly anytime soon.

Our forecasts are that the global market will

remain in surplus, though the annual surpluses are

expected to decline over the next few years.

So far this year, LME spot prices have traded at

USD1,800-2,300/t, averaging USD2,077/t. We

see USD1,900/t as a good support level for

aluminium prices unless there is a full blown

global recession which we do not expect.

Aluminium – structural oversupply to persist

Global market set to remain in surplus, with strong Chinese output

growth and slow Western production cuts

China will remain self-sufficient with opportunistic imports only

dashing the hopes of Western producers

We forecast LME aluminium prices at USD2,110/tonne in 2012e

and USD2,200/tonne in 2013e

HSBC LME aluminium price forecast LME and SHFE (ex VAT) spot aluminium prices (USD/t equivalent)

0

200

400

600

800

1,000

1,200

2009

2010

2011

2012

e

2013

e

2014

e

2015

e

0. 60

0.70

0.80

0.90

1.00

1.10

1.20

Global surplus (kt) - LHS Prices (USD/ lb)- RHS

1,600

1,800

2,000

2,200

2,400

2,600

2,800

Jan-

10

Apr-1

0

Jul-1

0

Oct-1

0

Jan-

11

Apr-1

1

Jul-1

1

Oct

-11

Jan-

12

Apr-1

2

Jul-1

2

SHFE LME

Source: Bloomberg, Brook Hunt, China Metals, HSBC Source: Bloomberg, HSBC

34


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We expect LME aluminium prices to average

USD2,110/t in 2012e, USD2,200/t in 2013e and

USD2,400/t in 2014e with prices rising as the

annual surplus declines.

Shanghai Futures Exchange (SHFE) prices have

been less volatile than LME prices over the past

18 months. There is a 15% duty on aluminium

exports from China and typically SHFE prices

trade at a discount to LME prices.

We forecast SHFE prices (including VAT) of

RMB16,166/t in 2012e (RMB15,970/t in 1H12),

RMB16,830/t in 2013e and RMB17,200/t in 2014e.

We estimate that at current prices of cUSD1,900/t,

c59% of global production is loss-making. Adding

the cUSD200/t physical premium to the LME

price, c37% of production is loss-making.

Looking at the aluminium cost curve for the world

ex-China, we estimate that c36% of capacity is

loss-making at USD1,900/t and c20% is loss-

making at USD2,100 (considering the USD200/t

premium). No wonder then that we are now

seeing production cuts, not only in China, but in

the West as well.

Our price forecast of USD2,110/t for 2012

represents the 80th percentile of the ex-China

aluminium cost curve.

Global market to remain in surplus We expect the global aluminium market to remain

in surplus over the next few years as demand

growth fails to keep pace with rising supply. We

see strong supply growth in regions that have

witnessed rapid recent capacity additions

including China and the Middle East.

HSBC aluminium supply and demand model (kt)

2011 2012e 2013e 2014e 2015e

World capacity 53,016 54,801 56,816 59,198 61,056 y-o-y 7.8% 3.4% 3.7% 4.2% 3.1% Capacity utilisation 83% 85% 87% 88% 89% World production 44,237 46,344 49,285 51,850 54,295 y-o-

china equity july 2012 metals & mining -...

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