Consumption in China: From commodities to karaoke

Mark Mobius is portfolio manager of the Templeton Emerging Markets Investment Trust and executive chairman of Templeton Emerging Markets group.

There has been great concern regarding the slowdown of growth in China and its impact on commodity demand and, therefore, commodity prices.

Crude oil’s price gyrations tend to get the most attention, but China’s share of global oil consumption is about 12%, which is significant but less than that of the United States.

One could argue that Chinese demand patterns likely have played an even greater part in influencing prices of many other commodities where China holds an even larger share of global consumption. China’s share of global grain consumption was around 22% in 2014 and its share of global metal consumption tripled from 13% in 2000 to 47% in 2014.

China is a key consumer of aluminum, nickel, copper, zinc, tin and iron ore. Of course, China isn’t only a consumer of raw commodities—its growing middle class has been exerting formidable purchasing power and spawning new domestic industries that are of keen interest to us as investors, including cosmetics, entertainment (cinemas, music) and more.

As China continues its transition to a domestic-led economic model from one that has been primarily export based, the country’s overall gross domestic product (GDP) growth has slowed.

A slowing in growth is to be expected given the tremendous increase in the size of China’s economy over the past couple of decades, but we must not forget the dollar value of its economy has grown tremendously.

There has been some debate about how China’s demand for commodities overall will change as its economic model shifts. We think China’s energy and metal consumption is more likely to increase than decrease over the long term given the tremendous growth and improvement in infrastructure that is still needed in China compared with developed countries.

This sustained demand is likely to be fueled by continued migration from rural areas in China to the cities, in our view. However, we recognize that demand may not meet previous expectations of various commodity-producing firms, which may have overestimated demand growth from China and other parts of the world.

Importance of Iron Ore in Infrastructure

The demand for iron ore—a key component of steel and of critical importance in infrastructure—is of particular significance to China, which holds 50% of the world’s share of crude steel production.

Of course we expect that share could decline as China’s economy becomes more consumer-oriented and less dependent on infrastructure for growth while other countries such as India enter a period of high infrastructure development.

In any case, China currently has become so influential that the global benchmark price of iron ore—which used to be determined in Japan—is now based on the price on delivery at Chinese ports. China’s booming steel production, however, has come with a cost—clouds of pollution over its capital Beijing.

Premier Li Keqiang has vowed to find solutions to clean up the air, including stiffer penalties for violators of anti-pollution laws and regulations.

Ceremonies in Beijing tied to the 70th anniversary of the end of World War II in early September resulted in the closure of thousands of steel factories in the region and the stoppage of thousands of construction sites in order to cut down on pollution during the events.

The government also has enacted policies to cope with overcapacity in the steelmaking area, shifting some production from Hebei province (responsible for most of Beijing’s smog) to the coastal areas.

Recycling of steel is also expected to increase in China, which could impact long-term trends in production, pollution—and prices.

While we certainly can’t predict where commodity prices will go next, we do know that as a result of its large role in commodity consumption, China is now becoming a center for commodity trading previously dominated by London and New York. One example of this is the purchase of the London Metal Exchange in 2012 by the Hong Kong Exchanges and Clearing Ltd.

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