China – Look For The Commodities That Are Less Oversupplied


China’s interest rate cut has got everyone’s attention today and the markets are rallying as are most commodities.  We have seen interest rate cuts all over the world over the last two years and their impact on economic growth/consumer spending has generally been positive, but not dramatic.  If we assume the same for China, some of these commodity moves may be premature, as even with increased demand in China we have so much global overcapacity that incremental demand from China may not be enough.

Iron ore, for example, is in such significant oversupply that incrementally better demand in China will likely not be enough to make a difference and any price response will be met with a supply response, as we saw with Aluminum through 2012 and 2013 – see chart.   It is unlikely that lower rates in China will lead to significant increases in infrastructure spending, so Iron ore and Steel are going to have to rely on consumer driven demand increases – for example in Autos.

Increases in consumer spending in China and possible also in Europe, as Draghi unlooses every tool in his belt to stimulate growth, would be good for Autos, but also for housing and other consumer goods.

We would focus first on Aluminum as a way to play this change.  We know from the way that prices have moved this year that the global Aluminum market is in better shape that it was a year ago, and growth rates are already strong.  Alcoa would be the big winner here and we still see significant upside in the stock: we continue to believe that it could double.

A second focus might be Titanium Dioxide; DD and HUN in our universe.  This is a commodity very much at the bottom of the cycle, but better autos and housing means better paint demand.  There is an oversupply here and it is focused in China, and it is not obvious how close we might be to a point of inflection.  There is still more capacity coming on line in China and while valuations are interesting for both companies they are not nearly as compelling as they were for Alcoa when we made the initial recommendation to own the stock.  DD is in the process of carving out its TiO2 business, either for sale or for spin, but it will remain part of DD most likely through the middle of 2015.


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