By Wayne Yamada
Chinas huge appetite for industrial minerals was the result of decades of frantic construction activity.
But why are Chinese people obsessed with property? And how might a crash unleash havoc for the global mineral markets?
China is addicted to building and buying property. This has led to huge industrial minerals demand from every construction sector including ceramics (kaolin, feldspar, talc), metals, manufacturing (bauxite, magnesite, chromite), and pigments (titanium dioxide, iron oxide), among others.
While times were good, developers and investor ploughed money into building row after row and stack after stack of brand new apartment blocks. Fields were turned into tower blocks faster than in any other time in history.
And even more money funded construction when China propped up the world economy during the 2008 financial crisis by unleashing a $586bn stimulus spending programme. But the failures in the global banking system continue to ripple, with the eurozone debt crisis and a wobbly US recovery finally slowing the once unstoppable Chinese economy.
The cracks are now beginning to show in the worlds largest construction sector, and could threaten to bring the whole global industrial minerals house down.
Why the rush into property?
In China, people are getting richer but instead of spending, they feel like they have to save for two reasons.
The first is due to the one-child policy. In the past, grandparents had numerous grandchildren to depend on in old age. Now every four grandparents have one grandchild to depend on, so people have to save, or risk poverty in old age.
Secondly, China has no safety net no welfare state in times of illness, unemployment, and old age. So people have to save to protect themselves unlike in other countries which provide support in times of strife.
But the growing Chinese middle class have limited saving options. State-owned banks have interest rates capped by the government (which are below rates of inflation) and the stock markets are perceived to be corrupt.
So property represents a good investment if you believe prices are rising and you can sell the building at a later date.
It is this which has driven the boom in construction in the past three decades, made worse by a rush of state-owned firms also desperate to pile into property speculation.
And now, a dangerously large proportion of the economy relies on the property market not failing.
Residential construction accounted for 9.2% of Chinas gross domestic product (GDP) in 2011, according to the US Peterson Institute economist Nicholas Lardy, which is higher than 6% in the US during its housing boom in 2006.
In major countries, only Spain has hit those levels.
Rating agency Fitch estimates around 35% of bank loans are directly or indirectly tied to the Chinese property market while Swiss bank UBS reckons it is around 40-50% of outstanding loans.
Residential property also accounts for around 25% of all Chinese steel consumption, according to Lardy, directly affecting refractory and foundry mineral consumption. He also estimated nearly a fifth of Beijing residents own two or more apartments in the city.
The 2008 financial crisis started when investors realised toxic US subprime mortgages were worthless. Now in 2012, the industrial minerals market should look nervously at Chinas shaky property market, because doubts are rising about whether or not Chinese investors can pay back loans on properties and if a slumping market could spark panic selling.
Bear bites dragon
Furthermore, the outlook for property prices and the Chinese economy is not looking good. The average price of homes in 100 major cities had fallen nine months in a row to May and house prices are 1.9% lower than last year.
Chinas largest machinery maker, Sany Group, is also cutting jobs which could be a sign of rising unemployment, hitting people's ability to pay mortgages.
Lay-offs [in Chinas machinery industry] have never happened in the last 10 years, even during the downcycles in 2005 and 2008. Definitely this downcycle is much tougher than before, Barclays bank analyst Victoria Li said.
There are other bearish signals. Chinese steel maker profits for Jan-Apr 2012 slumped 49.5% year on year according to Chinas National Development and Reform Commission.
Coal inventories are also at record highs, meaning electricity demand (and therefore industrial activity) is down. Even the price of pork has fallen to a point where the government has had to step in to support prices.
Chinas June HSBC Purchasing Managers Index (PMI) which reflects the health of the manufacturing sector fell eight months in a row, showing contraction.
Source: HSBC Purchasing Managers Index, compiled by Markit
It is all about growth and employment. As external demand has weakened and domestic demand hasn't shown a meaningful improvement in response to earlier easing measures, growth is likely to be on track for further slowdown, hence weighing on the jobs market, Hongbin Qu, chief China and Asia economist at HSBC, said.
Chinas economy depends on other countries buying the product it makes. But ongoing eurozone worries and a surprisingly low US PMI suggests overseas consumers are in no mood to spend.
Austerity measures imposed on countries such as Greece, Italy, and Spain have resulted in shrinking GDPs and rising unemployment. The Greek unemployment rate grew to 17.7% in 2011 compared with 12.5% in 2010, according to European Union (EU) data.
Spanish unemployment was up to 21.6% from 20.1% the previous year.
The US Institute for Supply Management (ISM) manufacturing PMI for June also fell to 49.7% below the benchmark 50% and therefore indicating contraction versus a healthy 53.5% in May.
But banks and policy makers are not without mechanisms to halt declines. And ironically, the worse it gets, the more likely they are to act.
After China cut interest rates for the second time in month, the European Central Bank (ECB) also cut borrowing costs to 0.75%, the lowest since the creation of the euro in 1999. The Bank of England also injected another £50bn ($77.4bn) into the economy via another tranche of quantitative easing.
Chinas latest inflation fell to 2.2% in June below government targets of 4% which could be the trigger for more government spending. Negotiations at the EU leaders summit in late June were, at last, starting to make inroads into fixing eurozone debt problems.
The euro summit outcome was very positive for banks: finally politicians agreed to take a big step towards banking union and centralised regulation, Société Générale head of global research, Patrick Legland, said.
And even in the Chinese property market, things may not be as bad as it seems. Despite prices falling for nine months in a row, US investment bank Goldman Sachs said it believed property prices may rise in June.
The apparent sales recovery likely reflects pent-up demand for property, lower interest/mortgage rates, and discounts on mortgage rates for first-time buyers, Max Layton, senior metals analyst at Goldman Sachs, said.
Our China strategy team expects that 19% year on year (y-o-y) growth in commodity [property bought on the open market] and social housing completions will drive an 11% increase y-o-y in total Chinese construction completions in 2012. In 2013, 27% growth in social and commodity housing completions is expected to drive 14% overall growth.
So a lot is riding on the Chinese property market. And you can deflate a bubble if you act carefully, decisively, and swiftly. But all it takes is one wrong move for the bubble to burst, and the size of this pop could send huge shock-waves around the world.