Is China's Year of the Ox commods binge all bull?

Unfortunately for the bulls, the buying binge that kicked off the Year of the Ox last week had more to do with speculative deals, inventory re-stocking, government buying and post-holiday catch-up than with the start of an upturn in the real economy.

"Not the beginning of the end," Citigroup analyst Alan Heap called it in a recent note to clients.

"Beyond a potential short covering rally, underlying demand will likely remain weak through to the second half of 2010 and surpluses are forecast to increase across the complex for at least the next two years," he said.

Official figures are unlikely to be much help anytime soon, with this week's trade and output data for January distorted by the new year holidays, which last year fell in February. Coming months will also be distorted by comparisons with last year, when winter storms and an earthquake hit industrial production.

Meanwhile markets are focusing on short-term trade activity, including stepped-up iron ore imports from Brazil, arbitrage crude from Russia, a rash of unusual rubber purchases and a spate of soybean deals from Latin America to support the idea that the world's fastest-growing commodity consumer is on the mend.

With the moribund world economy struggling to see a way out of recession, however, sceptics question whether export-focused China has found enough demand to revive its own fortunes.

And not all commodities were equally impressed. While copper price rose strongly, oil and grain markets were flat last week.

STOCKING UP

At least a portion of the latest spate of buying can be explained by importers and corporates re-stocking inventories that they had let dwindle as demand fell in recent month, or which declined over the lengthy Lunar New Year holiday.

Part of this demand comes from the government itself, which is taking advantage of low prices for oil, copper, aluminium, zinc, indium, rubber, fertiliser and sugar to build up reserves.

But these purchases -- unlike China's purchases of cotton, soybeans, corn and rice, which are meant to help farmers -- are generally far too small to revive world prices, let alone demand.

How about the government's 4 trillion yuan ($600 billion) stimulus, an attempt to support economic growth, which slipped to 9.0 percent in 2008 after five straight years in double-digits?

It includes 600 billion yuan for railway building in 2009 and funds for construction and agricultural infrastructure, which most analysts say should benefit suppliers of cement and steel.

The Railways Ministry estimates its portion of the stimulus will raise demand for steel by 20 million tonnes in 2009, according to analysts at Bank of China International.

But that represents a mere 4 percent of China's 2008 steel output, which is likely to fall in 2009 because of the collapse of global demand for cars, ships and construction.

"Since the 1990s, a steel industry downturn has lasted around 15 months and it has gotten shorter gradually, driven by strong demand from emerging markets. But this time it may take a bit longer because demand is simply not there," said Eom Jin-seok, an analyst at Kyobo Securities.

RECOVERY ROOM

But Andrew Forrest, chief executive of iron ore supplier Fortescue Metals Group thinks recovery is on the way.

"China's slowdown is not linked to the global financial crisis," Forrest said in presentation materials for a speech this month. "China's recovery will be rapid as demand for mineral resources for urbanisation and industrialisation returns."

Marius Kloppers, Forrest's opposite number at BHP Billiton, the world's top miner, is also optimistic.

"The de-stocking is essentially complete," he said last week.

Both the government and the iron ore miners have an interest in talking up the steel sector: the former is eager to reassure the world that economic growth will not go below 8 percent; the latter are locked in annual iron ore price talks, with a healthy steel market the best argument for a high iron ore price.

They can point to a 7 percent rise in Chinese steel exports and output in December. For a graphic, please click here

But that may be due to the government scrapping export tax on high value-added steels such as cold-rolled products, which are used in autos and home appliances and have dire demand prospects.

The demand recovery is a mirage, some say.

"Such jumps have never proven sustainable without an underlying recovery in property construction or related real import demand," said Jonathan Anderson, an economist at UBS.

"And here we have no real sign as yet that things are stabilising, much less set to rebound tomorrow."

China's steel mills are running at 70-80 percent of capacity, up from from about 60 percent in early November and nearly double the 40 percent seen in the United States, according to Macquarie.

"China's move to raise production in particular is a concern, with the government encouraging steel exports by cutting the export tax," said Christina Lee, an analyst at Macquarie.

"This implies that Chinese supply should increase in coming months and weigh on the global steel price recovery," Lee said.

SHIPS IN A SPIN

What cannot be explained by spin-doctors is last week's 50 percent leap in the Baltic Dry freight index, showing new interest in shipping bulk commodities such as iron ore and coal.

Some warn that even that may not last.

"Chinese iron ore imports have been a primary impetus behind the surge," said Jeffrey Landsberg, a freight options broker at Imarex in Singapore. "But a large amount of vessels full of ore are now waiting outside Chinese ports to unload.

"As a result, Chinese steel production must start increasing now. If not, freight rates will likely come down in the near future."