Key points
•    We have returned from our recent visit to China, with further positive conviction regarding the outlook for the Chinese economy and implication for commodities related demand.
•    China has emerged from a strict COVID-zero policy, progressively opening the economy again and ramping-up its consumption of key commodities.
•    We see the consumption recovery, ongoing infrastructure strength and a property rebound underpinning our expectations that the “around 5%” GDP target for 2023 should easily be met.
•    Building blocks for an acceleration in infrastructure construction-related spend are in place. 2022 saw a wave of infrastructure funding and approvals put in place, which has continued into 2023.
•    The property sector, which was a major headwind during 2022, has turned positive at both the developer and consumer level through a range of policies, with early data and anecdotes suggesting the sector has turned, and should support commodities demand over the course of the year.
 
Context: The slowing economy of 2022

China has undergone a significant period of internal transformation and long-term growth marked by the rapid urbanisation of its rural population over the last four decades. The rate of urbanisation has undergone sustained expansion moving from 19% in 1980 to 62% in 2021 as China continues to push towards becoming a developed advanced economy, as illustrated in Chart 1. This has not just been achieved with the rural population moving to existing cities, but a mix of existing cities and the development of new cities and regions that has driven significant commodity demand.

Chart 1: The rapid urbanisation of China

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Source: The World Bank

In order to move away from its emerging market status, the Chinese government implemented several significant policies to encourage economic growth, including the urbanisation pilot program, land reform policies (assistance provided to developers in the acquisition of affordable land), and a combination of both infrastructure (high speed rails, airports, and freeways) and property development.
China has used state-based policy and investment stimulus to coordinate its growth strategy on the path to transforming itself into a major global economic power. China’s rolling 5-year plans place emphasis on a wide range of investment focal points in order to elicit economic growth in the areas of property, energy, transportation, industrial development, education, healthcare and environmental protection.
Since 1978, China’s GDP growth has averaged 9% per annum, with a significant proportion of the population lifted out of poverty, supported by access to infrastructure, education, and health. Economic growth in times of post economic uncertainty has been driven by rebounding economic activity through aggressive domestic stimulus. Leading into Covid, we saw a reduced focus on stimulus activity, as the Chinese government focussed on a more service-based economy. Following the impact of Covid on the Chinese economy, we see very strong evidence old style physical stimulus policies being used to support the economy, in a similar manner to the post GFC policy.
Post the Global Financial Crisis (GFC) the Chinese economy grew by 9.7% in 2008, 9.4% in 2009 and 10.6% in 2010, underpinned by major stimulus programs introduced from the fourth quarter of 2008 and implemented in subsequent years. Further to this, the government formulated a package that consisted of accommodative monetary policy, tax cuts, measures to reduce the burden placed on state-owned enterprises, and broad-based investment and construction programs.
In 2022, the country’s economic growth decelerated materially, with GDP recording just a 3% increase, with COVID-zero restrictions remaining in place for the majority of the year and weighing on growth. Conservative growth estimates for “at least 5%” (National People’s Congress) have been targeted for 2023 with the combination of consumption recovery and government-led stimulus being the main drivers that are likely to support and may command a significant beat to this economic growth rate, assuming no significant surprises. The GFC provides an apt comparison, with China demonstrating a pro-growth stance at times when ex-China economies are struggling to generate growth or have entered recession.

Chart 2: China GDP growth


   

GDP is set to accelerate through 2023 given the pent-up demand pressures driven by stimulus policies that have already been put in place. Ausbil forecasts GDP to reach 5.1% for calendar 2023, and 4.8% for calendar 2024 (Table 1), well outperforming expectations for global growth as stimulus has its effect. GDP forecasts are set to stay elevated over the near term as the government has shifted to pro-growth stance.

Table 1: Ausbil growth forecasts for China v world


Source: Ausbil forecasts as at 15 May 2023.

To ensure an improving GDP environment, China has and will continue to fuel its economy through stimulus spending, particularly through energy and infrastructure development which is commodities intensive, and directly drives global commodity demand. In 2021, China was the dominant force in the consumption of global commodity output, consuming a minimum of 50% of all core commodity supply globally. In particular, China dominates Iron ore demand, consuming roughly 70% of global demand, with improving construction-related activity clearly supportive for steel, and therefore iron ore, consumption. Chart 3 illustrates the depth of China’s dominance in commodities.

Chart 3: China dominates commodity demand in this epoch of growth

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Source: Credit Suisse, Bloomberg, 2021 base demand year.

The post-pandemic recovery in activity
China abruptly changed its hard-lined COVID-Zero policy during November of 2022, with an immediate relaxation of restrictions. Following the initial period of slowing activity that resulted from COVID impacting the populus, a swift return to normalcy can be seen in effect with a reopening wave having swept through the economy. This is clearly illustrated in the available high frequency data improving on traffic congestion, coal and steel consumption and oil demand, which in some instances have returned to pre-pandemic levels. Arguably this strong demand backdrop could be supported by pent-up demand in post-lockdown activity, but we argue that stimulatory policies are also providing significant support for economic activity.
It must be noted that there is a significant seasonal impact each year from Chinese New Year and the significant drop in consumption that occurs in each first quarter. As highlighted, the current high frequency data suggests activity is returning to and potentially above pre-pandemic levels. Chinese coal consumption is high, suggesting activity levels are stronger, as illustrated in Charts 4 and 5. Furthermore, China’s current electricity generation is above the 5-year average. Elevated electricity consumption further supports the view that economic activity is improving considerably.

Chart 4: Daily coal consumption in coastal provinces

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Source: Haver, CCTD, Mysteel, Goldman Sachs Investment Research.

Chart 5: Resurgence in electricity Consumption

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Source: Wind, Goldman Sachs Global Investment Research

In terms of steel, inelastic long-term demand for ore used in steel production has seen iron ore volumes through Chinese ports grow across time, as illustrated in Chart 6. Demand for iron ore is linked directly to construction related activities focused on infrastructure spend which has cycled into higher rates of internal growth across the economy in a multiplier effect.
Anecdotally, having recently spent time in China, we would add that the elevated pollution levels in Beijing are indicative of the return to vigorous activity across China’s steel mills, particularly in processing Australia’s iron ore exports into pig iron, stainless steel, rebar, rolled steel and coil products, and other critical steel products for growth.
Chart 6: Inelastic long-term demand for bulks: Long secular demand for iron ore



Source: Ausbil, using China customs data from Bloomberg.

As illustrated in Chart 6, iron ore volume had risen strongly prior to COVID, however during the pandemic this growth fell and plateaued, though maintaining relative strength ranging between 80 and 100 million tons (Mtpa) per quarter. Following some stagnation in iron volume demand growth, we are expecting volumes to resume their strong upward trajectory fuelled by China’s spending on infrastructure and property stimulus, and a resumption of economic activity following the hard COVID lockdowns of 2021 and 2022.

Outlook: Commodities demand driven by rebounding infrastructure and property
One of the key areas of strength during the COVID-weakened period in 2022 was infrastructure. Infrastructure represents roughly a quarter of Fixed Asset Investment (FAI) in China. Local Government Special Purpose Bonds (LGSPB) are one of the key financing mechanisms for infrastructure related spend. Issuance of LGSPB during 2022 was significant, with the government minting RMB4tn in new bonds, a step-up of roughly 15% on the previous year. The Chinese government front loaded LGSPB issuance with RMB1.4tn being issued from January to-April (up 130% year-on-year, accounting for almost 40% of the annual quota in just 3 months. From here there was a further acceleration in spending, with the issuance of RMB1tn in each of the months of May and June 2022.
This accelerated spend is key to the 2023 recovery and a commitment by the government to boost the economy through infrastructure investment. 2023 has already seen another front loading of issuances similar to 2022.
These building blocks are in place for a rebound in construction activity through 2023. 2022 data was extremely positive with FAI projects approved by the National Development and Reform Commission (NDRC) exceeding RMB1.6tn in projects, which was roughly double the approvals in 2021.

Chart 7: Cumulative issuance of Local Government Special Purpose Bonds

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Source: Wind, Goldman Sachs Investment Research.

Chart 8: FAI infrastructure projects approved by NDRC.

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Source: Wind, Goldman Sachs Investment Research.

Unlike infrastructure investment, the outlook for property growth in China is not yet clear. The consensus outlook for property has been very weak, with expectations that it would be a major drag on economic growth. We would highlight our view that the weakness in the Chinese property market has arguably been driven by government policies looking to reduce both leverage and speculation within the sector. Consensus has been expecting new builds to decline by more than 5-10% over 2023. However, supportive policy at both the developer and consumer levels may potentially lead to an unexpected counter-consensus resurgence in growth. We have already seen a kick-up in property transaction at the start of 2023, as illustrated in Chart 9, a trend we think will continue with further stimulus and bond issuance. This increase pricing has led to an increase in volumes China continues to emerge from their hard COVID lockdowns.

Chart 9 - Property transaction volumes

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Source: Wind, Goldman Sachs Investment Research

Conclusion
Early indicators on activity levels continue to be positive, on coal consumption, traffic congestion and transit data and we expect underlying activity to accelerate in coming months. We see the consumption recovery, ongoing infrastructure strength and property rebound underpinning our expectations that the “around 5%” GDP target for 2023 should easily be met. Building blocks for an acceleration in infrastructure construction- related spend are in place. 2022 saw a wave of infrastructure funding and approvals put in place, which has continued in 2023. This has setup the groundwork for a strong work program in 2023, where we witnessed green shoots of activity during our trip. Support for the property sector, which was a major headwind during 2022, has turned positive at both the developer and consumer level through a range of policies, with early data and anecdotes suggesting the sector has turned, and should support commodities demand over the course of the year. Subsequent to our return, very strong Chinese construction PMIs (Purchasing Managers’ Index) have supported these views.
There are a few risks to this outlook. The first risk is COVID and potential new outbreaks, however the World Health Organisation declared the end of COVID-19 as a global health emergency on 5 May 2023. Risks exist around slowing growth and a decline in cyclical demand for resources, however, the mitigant to this is the prevailing underinvestment in supply over the last decade. We believe the fundamental demand overhang will ensure ongoing support for commodity consumption, particularly from the world’s dominant consumer of global resources, China.
 
Fund Strategy
Across the broader Ausbil Global Resources portfolio, we maintain a long net exposure as we see more certainty around increasing Chinese demand in 2023, although we are running elevated levels of protection to reflect banking system uncertainty which can impact overall equity market sentiment. We continually reassess our exposures, and tactically adjust our portfolio depending on the outlook. We have taken the opportunity to capitalise on recent weakness within resources and equity markets, to reposition the portfolio in order to fully capitalise on the China reopening. We see Base Metals (Copper and Nickel in particular), Oil & Gas, and Battery Materials as core commodity beneficiaries, both from an acceleration of construction and consumption-related activity in China, and as such these now represent a large part of our core positioning within the portfolio.