COLUMN-Stronger China economy a boost for commodity demand? Maybe not: Clyde Russell

Russell@

--Clyde Russell is a Reuters market analyst. The views expressed are his own.--

By Clyde Russell

LAUNCESTON, Australia, Jan 21 (Reuters) - It sounds logical that China's re-accelerating economic growth and industrial output are positive signals for commodity demand, but that's not necessarily the case.

There appears at best to be a very loose correlation between gross domestic product and industrial output on the one hand, and growth in imports of crude oil, iron ore and copper on the other since the end of the 2008 global recession.

What appears more likely is that there is a level of base demand related to economic growth and industrial activity, but that the peaks and troughs of commodity demand are more correlated to inventory and price cycles.

Gross domestic product grew by 7.9 percent year-on-year in the fourth quarter, up from 7.4 percent the previous quarter, and industrial production by 10.3 percent, the fastest pace in nine months.

Both these numbers were above the consensus expectation and have almost universally been interpreted as a sign that China's economy is regaining momentum from the slowdown engineered by the authorities to tackle inflation and the risks of asset bubbles.

Commodity demand was also fairly strong in 2012 despite the mid-year economic slowdown that roiled prices, especially for iron ore.

Crude oil demand was 7.3 percent higher in the 12 months to December, while iron ore was up 8.4 percent and refined copper imports surged 30.3 percent.

But in 2011, when GDP grew by 8.9 percent and industrial production by 12.8 percent, oil demand grew at just 5.5 percent from the year before, while copper appetite increased by only 5.9 percent.

Only iron ore import demand was stronger in 2011 than 2012, growing by 10.9 percent in the earlier year.

However, iron ore demand was negative in 2010 at -1.5 percent, a year in which GDP jumped 9.8 percent and industrial output by 13.5 percent.

A graph of China GDP against iron ore imports shows a high degree of correlation prior to the 2008 financial crisis, peaking at 0.884 at the end of 2007, with 1.0 being perfectly correlated, 0.0 having no linkage at all and -1.0 being perfectly inversely correlated.

Since that peak the correlation steadily sunk to around zero by mid-2009 and has declined to -0.67 as of the end of 2012, meaning that iron ore imports are now more likely to move in the opposite direction to GDP growth.

Charting spot iron ore prices <.IO62-CNI=SI> against imports shows that peaks in prices generally have been followed by lower imports and vice versa.

For example, when prices tumbled to a three-year low in September last year, iron ore imports had jumped to 70.94 million tonnes by December from 56.43 million tonnes in October.

Conversely when prices rose to above $180 a tonne in January 2011 from around $130 in July 2010, imports tumbled to 48 million tonnes in February 2011 from 69 million that January.

Even allowing for the effects of the Lunar New Year around that time, imports were still weak for the following seven months, not climbing above the 60 million tonnes-a-month mark until September 2011.

Much of the strength behind record iron ore imports in December last year was put down to steel mills restocking, and not just the price weakness in the prior months.

If it's a valid argument that commodity imports are more driven by price and inventories than by economic growth, then the 81 percent jump in the spot price to the peak earlier this month from the low in September should result in a slackening in import growth in the next few months.

Turning to crude oil, and it appears that much of the growth in 2012's imports was because of inventory building in the first half, with a gap of as much of 500,000 barrels per day between imports and implied consumption.

This stockpiling of both commercial and strategic reserves meant crude demand was stronger than it should have been under the prevailing economic circumstances.

Copper imports are even less reliable as an indicator of economic activity, given the role of the metal as a vehicle for financing.

While stronger economic activity will almost certainly result in increased commodity demand, this probably only works over a longer-term view and isn't necessarily helpful in working out the likely path of imports over a time horizon of up to about six months.

(Editing by Joseph Radford)