By John Richardson
WHEN something appears to be good to be true, it usually is.
Back in 2009, China’s demand for polyethylene (PE) increased by more than 20% – way above the increase in GDP – because of just about the biggest injection of credit into an economy in history, as our top chart illustrates.
The problem was that at that time too few people asked hard questions and so failed to see the obvious: That this rate of growth was unsustainable and so had to come to an end, which of course it did from April 2011 onwards as China tightened-up in credit in order to tackle inflation.
Next came a recovery in PE growth versus GDP growth, as the top chart again illustrates, during a period when credit conditions were once again loosened.
And so what should we make of the chart below?
As you can see, China’s PE demand was up by a staggering 25% in January-May of this year when compared with the same period in 2012. Unlike in 2009, this has occurred at a time of reduced headline credit growth.
But experience tells us that much of this demand must still be speculative – on this occasion tied into complex “collateral trades”, funded either by offshore loans or through China’s shadow banking system.
Many of these traders are likely prompted by panic as speculators across multiple categories of commodities and real estate attempt to complete property deals before the property market weakens any further.
No other explanation stands up to scrutiny, given that 25% of growth in PE demand so far this year compares with full-year GDP growth which is likely to be in the region of 7%.
There is simply no way that actual, real demand for PE can be increasing at a rate around three times higher than GDP. The lesson of 2009 shows us that this cannot happen.
We are instead seeing a speculative build-up of inventories in PE that at some point will have to be unwound.