Chemicals & The Economy

Economic recovery is already underway, according to the optimists who have bid up financial markets in recent weeks. But the blog's quarterly review of company results shows little evidence of it on the ground.

Phrases such as 'challenging', 'economic uncertainty', 'deterioration' and 'decline' dominate the reports across all major regions:

• Europe is clearly in worst position, with the critically important auto and housing industries in long-term decline
• But Asia is also weak, as the new Chinese leadership refocuses policy on the broad mass of the population
• And even the US provides few bright spots, with political gridlock undermining optimism over feedstock costs

Equally, there is little distinction between the outlook of the commodity and specialty sectors. In fact, as the blog will discuss in more detail next week, these labels appear increasingly out-of-date. Instead, the critical distinction is becoming between 'Niche' and 'Mass-Market'.

Companies such as Bayer, Croda and Arkema highlight the New Normal into which we are transitioning. Croda, for example, are one of the very few companies to have noticed that the ageing BabyBoomers are now the only growth sector in the Western world. And they have successfully developed new high margin, niche products to meet their needs.

Air Products. "Globally, economic growth underperformed our expectations"
Air Liquide. "Increased hydrogen demand for refining and chemicals in Asia and US"
AkzoNobel. "Economic environment remains challenging"
Arkema. "Repositioning the portfolio towards high added value niche markets"
Asahi Kasei. "Deteriorating market conditions in the chemicals and electronics segments"
BASF. "Expected increase in demand, together with measures to improve operational excellence and raise efficiency"
BP. "We expect margins to remain under pressure during 2013"
Bayer. "Strategic focus on these markets of the future - and the investments we are making there - are paying off"
Borealis. "Weaker polyolefins margin environment in Europe"
Celanese. "Challenging global environment would continue throughout 2013"
Clariant. "Expects the soft macroeconomic environment to persist into 2013"
Croda. "Benefited from the trend among ageing populations to spend more on cosmetics to preserve a youthful appearance"
Dow. "H2 2012 saw significant deterioration in the markets we serve, particularly in China"
DSM. "High benzene prices, new capacities in market, combined with weak end-use markets in fibres caused a sharp deterioration in margins"
DuPont. "A slow-growth world economy"
Eastman. "Cheaper costs for raw materials and energy more than offset lower sales prices"
EQUATE. "3% increase in profit, backed by record sales.
ExxonMobil. "Higher margins increased earnings by $330m"
Honeywell. "Challenging end market conditions"
Huntsman. "Programs will enhance our future competitiveness and increase shareholder value"
INEOS. "Markets in Europe and Asia have continued to be subdued...business in North America has been strong with the the benefit of the current feedstock advantage"
Indorama. "Ongoing slowdown in Chinese economic growth"
LyondellBasell. "Outside North America, the global olefins industry continues to experience low operating rates and profitability"
Methanex. "Longer-term outlook for the industry looks very attractive"
Mitsubishi. "Lower earnings at a petrochemical-related subsidiary"
Mitsui. "Lower sales volume in the basic chemicals segment"
OMV. "Margins were burdened by higher input prices"
PKN Orlen. "Higher olefins and polyolefins sales volumes year on year"
PetroRabigh. "Higher operational capacity in 2012"
Oxychem. "Economic weakness and increased competition in Europe and Asia"
Phillips 66. "Specialties, aromatics and styrenics benefitted from improved benzene margins"
Praxair. "North American results were mitigated by recessions in Brazil and Europe, moderating growth in China"
SABIC. "Higher sales volumes and sales prices for certain products"
Siam Cement. "Higher demand from flood-related rebuilding activities"
Shell. "Higher operating expenses and reduced US availability of advantaged feedstocks"
Sherwin Williams. "Increased paint sales volumes and higher selling prices"
Solvay. "Will maintain selective investments to support its growth engines"
Stolt Neilsen. "I do not believe in any significant recovery in 2013"
Styrolution. "Successful transfer of increased feedstock costs onto its customers"
Sumitomo. "Petrochemicals and plastics segment posted an operating loss"
Ube. "Poor performance in its chemicals and plastics segment"
Versalis. "Slightly better margins on cracking plants"
Vopak. "Uncertainty of economic recovery is likely to continue to dictate the agenda"
Wacker. "Earnings decline is mostly due to overcapacities affecting photovoltaic industry"
Westlake. "Benefiting from lower feedstock costs"

The best view is always from the top of the mountain.

As the chart shows, this is where we are today - for the 4th time since the H2 2008 crisis. And just as at the previous 3 peaks, nobody seems to be noticing that demand is again weakening fast. Instead, policymakers and investors are being swept along on a wave of euphoria that assumes full recovery is finally now underway. This is the same mistake they made in March 2009 and then Q2 2010, when assuming there would either be:

• A V-shaped recovery. Markets were initally completely confident that the G-20 stimulus programme would restore constant growth
• A W-shaped recovery. When this stalled, they were sure QE2 would ensure full recovery

Since then, they have continued to make exactly the same mistake of refusing to accept that demographics drive demand:

• The ageing global population means that demand will increasingly be focused on replacement products, not new ones
• And as people reach pension age, demand will only be for affordable 'needs' - not the expensive 'wants' that drove SuperCycle growth when they were younger

The blog's launch of its Downturn Monitor on 29 April 2011 successfully coincided with the absolute peak of the post-crash rally. The aim was to warn as clearly as possible that markets were now reaching their most dangerous phase.

This is the moment when a strong and long-lasting trend changes direction. Serious amounts of money can now be lost from this point, if people continue to instead believe that the subsequent weakness is only temporary.

The issue is simple. As the blog discussed last week, many people have continued to assume that the economic SuperCycle of constant growth from 1983-2007 was 'normal'. Policymakers have encouraged this belief with their latest Twist and QE3 stimulus programmes, and the $1.1tn Chinese lending programme in advance of November's Party Congress.

Yet today, all the physical products in the Downturn Monitor portfolio remain well below their 2008 peak. Only financial products such as the S&P 500 Index have made new highs. Even more worryingly, chemical markets in general are now acting as a leading indicator to warn that underlying demand in the real economy is again weakening:

• January was very weak. New data from the American Chemistry Council showed global operating rates at just 86.3%, versus 87% in 2012 and the long-term average of 90.8%
• Similarly China reported last week that its main manufacturing Index is now back at October levels - just 0.1% above the border of expansion/decline

So everything now depends on March demand. It, like January, is normally one of the 4 strongest months in the year (along with May and October). So with Easter on the 29th, Western factories should now be working overtime. Yet there are few signs of this happening.

Instead, and confirming the underlying change in direction, political problems are rising:

• Italy failed to elect the centre-left coalition that all the experts had predicted
• Equally, the end of the US presidential election cycle has removed the economic support provided for housing and auto markets during this period
• Instead, the US seems back in political gridlock with budget cuts now taking place.

In 6 months time, therefore, the blog would not be surprised to find all the 'experts' lining up to claim, as in 2007-8, that 'nobody could have foreseen the downturn coming'. Today, as then, the blog seems to be a lonely voice, focused on what is really hapening in the real world.

Companies now need to urgently develop a contingency plan to cover a Scenario where demand fails to return for the rest of H1. In turn, they should also assume that crude oil prices will begin to return to their historical levels, below $30/bbl.

Clearly this Scenario will be very difficult to manage. We can only hope that policymakers will not continue to make the adjustment process more difficult, by refusing to accept that demographics, not stimulus programmes, drive demand.

Benchmark price movements since the IeC Downturn Monitor's 29 April 2011 launch, and latest ICIS pricing comments are below:
Naphtha Europe, dark brown, down 17%. "Demand from the gasoline sector has weakened and petrochemical requirements for naphtha remain limited"
PTA China, red, down 13%. "Steep declines in China's PTA futures on concerns over global macro-economy and a slow recovery of downstream polyester demand"
HDPE USA export, purple, down 10%. "Latin America seeing cheaper material being offered from the Middle East"
Brent crude oil, blue, down 10%
Benzene NWE, green, up 2%. "Producer margins in Europe have come under pressure and many have elected to scale back production"
S&P 500 stock market index, brown, up 11%

CNN captured the world's imagination when launching 24/7 television coverage of the first Gulf War in 1991. For the first time in history, viewers were able to see what happening as it happened. And CNN used expert and experienced commentators to make sense of the pictures.

Some of the major media still maintain these high standards, despite the cost. But today, most 24/7 coverage instead concentrates on the excitement of being first with the story, and forgets about the context. Thus most commentary on US auto sales has moved from euphoria to concern between December - February. As the chart shows:

• December's sales (green line) were up 113k versus 2011
• January (red square) was up 130k versus 2012
• But then February was only up 41k

The December/January sales increases were seen as confimation that a strong economic recovery was now underway. They appeared particularly striking as they came during these seasonally weak months. But then last week's February data cast doubt on this narrative.

Auto sales have certainly been improving over the past 18 months, as buyers needed to replace worn-out vehicles. But overall, this has been a replacement market, not a burst of new purchases. And this may well have been the case with the recent jump:

• It followed Hurricane Sandy, which hit the US East Coast in early November, and was forecast to require 250k cars to be replaced
• Is it therefore coincidence that sales jumped as they did in December-January by 243k?
• Or were these simply the forecast replacement sales for those damaged in the storm?

It they were replacing storm-damaged sales, then February's slower pace would really be no surprise. We shall just have to wait till March's report appears to find the answer.

Today sees the start of China's annual National People's Congress (NPC) in Beijing, when the new leadership of president Xi and premier Li will formally take office. Judging by their activity since November, when the appointments were confirmed, we may well see major changes in economic policy being announced.

The key is the move away from the focus on export-led development, which has proved a dead end, as the blog discussed last month. Instead, the target will be to improve the incomes and living standards of the 80% of China's population who currently earn up to $10/day. This is a radical departure from current policies, which have focused on the 4% who earn over $20/day.

One example is the change taking place in the city of Ordos, in Inner Mongolia. It has been an empty city over the past 5 years, although built to house 1 million people. Now, however, it is being used to boost rural incomes as the picture shows:

• 500k farmers and herdsmen are now being moved into the city
• The aim is to increase their incomes from $400/year (Rmb 2500) to $1900/year

At the same time, the farmers are being allowed to keep their land, in the hope that less intensive cultivation will boost vegetation coverage from levels as low as 25%.

Further signs of the new policies include:

• Cooling China's over-heated property market with a 20% capital gains tax on sales and by (a) ending easy credit (b) tightening mortgage rules (c) widening use of property taxes
• Reducing the role of exports, which contributed 30% of GDP growth between 2001-8
• Cutting GDP growth targets in 14 of China's 31 provinces
• Reducing the pollution caused by the rapid expansion in car ownership and the growth of heavy industry - real-time data for 74 cities was published in January as a prelude to action
• Developing facilities for China's 200m senior citizens for the first time

All of these are major tasks in themselves. Together they amount to a complete change in economic direction.

Nobody can be sure that the new leadership has the ability to drive through changes of this magnitude. But the clear sense of urgency with which they are approaching the task gives some grounds for hope.

A critical change is underway in consumer buying habits as we enter the New Normal. The key driver for this is the switch from value-added to affordability:

• Value-added. The Boomers loved buying premium products when they were young. Companies rushed to support them, so that even tee-shirts became status symbols. Thus they were able to continually increase profits by adding extra features
• Affordability. But now the Boomers are entering their low-spending years. Equally, research evidence suggests their priorities are changing. They now value relationships with family and friends, and don't feel the need to boost their self-esteem with status symbols

As the chart shows, this is changing the industry landscape. In the New Normal, there are only two strategic choices, as the formerly profitable middle ground is now fast disappearing:

• Mass-Market, based on high volume and low margins
• Niche, targeting low volumes and higher margins

Croda Chemicals is a good example of how the latter strategy can prove very successful. It is one of the few companies to have noticed that the ageing Boomers are now the only growth sector in western society. As Croda CEO Steve Foots told the Financial Times:

"Croda's consumer care division - which accounts for more than half the group's total revenues - has benefited from the trend among ageing populations to spend more on cosmetics to preserve a youthful appearance.

"When we launch products, we launch them at higher margins than those already out there."

The blog is delighted to have been asked to address a wide variety of industry and investor conferences over the next few months.

The arguments of our 'Boom, Gloom and the New Normal' eBook are clearly starting to make sense to an increasing number of people. Details of the main events are below, and hopefully they will also provide opportunites for some of us to meet :

'Sustaining Growth as the West Arrives at the Demographic Cliff', keynote speech at Metal-Pages conference, London, 13 March
'The collapse of cotton prices: opportunity or threat?', presentation at ICIS PET Value Chain conference, Amsterdam, 14 March
Conference chairman, ICIS Chemical Purchasing Conference, 16 April, Brussels
'Managing a business in today's VUCA environment', keynote speech at Adhesives & Sealants Council Spring Convention, 22 April, Atlanta, Georgia
'Boom, Gloom & the New Normal - the Outlook for 2020', keynote speech at Pressure Sensitive Tape Council Summit, 14 May, New Orleans, Louisiana
'The New Normal in Latin America', presentation at Latin America & Caribbean Petrochemicals conference, 28 May, Paris
'The Global Economic Outlook', presentation at Euromoney Global Borrowers & Investors Forum, 26 June, London
'Sustaining Investment Returns As The World Reaches The Demographic Cliff', keynote speech at Super Returns Emerging Markets conference, 27 June, Geneva

Please don't hesistate to be in contact if you would also like the blog to deliver a relevant presentation at your own event or company workshop.

The blog's 6 monthly review of global stock markets highlights a very unusual pattern since global demand and chemical markets peaked on 29 April 2011, as the chart shows:

• Markets in developed economies have powered ahead with Japan up 24%, the US S&P 500 up 14%, the UK up 8% and Germany up 6%
• Markets in emerging economies have gone in the opposite direction with Russia down 24%, China down 20% and Brazil down 11%, whilst India is up marginally by 3%
• Meanwhile, the US 30-year government bond is up most at 26%

The rationale for this diverse performance seems to be:

• Demand remains very weak in all major economies, so export-orientated countries such as Russia, China and Brazil are suffering badly
• India is a more closed economy, so is less impacted by the loss of exports
• However Western markets have been influenced by the major central bank liquidity programmes, which have provided virtually free cash to investors
• They have therefore chased share prices higher just as in the dot-com and subprime bubbles
• More cautious investors, concerned over return of capital rather than return on capital, have instead gone to the safety of G7 government bonds

The history of Japan since its financial bubble burst in 1989 supports this interpretation. Every few years, a new premier has arrived who has promised to restore growth. This is what has happened recently since Abe was elected in December. Stock markets have routinely rallied 50% or more in response, as between 2003-7 when the Nikkei rose from 8000 to 18000.

But, of course, the political hype cannot hide the fact that Japan is now an ageing society, with the oldest median age in the world at 45 years. 45% of its population is now over 50 years, and so they only need replacement products rather than new. Equally, they have lower incomes as they move into retirement.

This is the same situation as in Germany, which also has a median age of 45 years and 44% of its population over 50 years. Other Western countries have similar age profiles, though not quite so extreme. Thus we can confidently expect the current market bubble to explode in time.

The tragedy is that the politicians, by failing to understand demographics, are creating a vicious circle. The liquidity programmes simply pile up more debt, to be repaid by the younger generation. So they will lose most, as their standard of living suffers in the future.

Famously, when Bill Clinton ran his successful presidential campaign in 1992, his advisers would remind him of the key message with just one phrase "Its the economy, stupid!". Today's policymakers would do well to maintain a similar focus on the oil price, if they want to understand today's lack of demand.

Somehow, everyone seems to have forgotten that oil prices over $50/bbl have always led to recession in the past. Similarly, they are now 5% of global GDP, compared to a normal level of half this. So it is hardly surprising that hard-pressed consumers cannot afford much discretionary spend. They have no spare cash after paying to heat their homes, and fuel their cars.

This would be bad enough on its own. But prices in two major markets - Europe and China - are actually at all-time record highs. So it is hardly surprising that domestic demand in both areas is particularly slow. As the charts show (Europe left, China right):

• Brent oil prices are now €87/bbl in Europe, due to the weakness of the euro. This is above the peak level of 2008 (€86/bbl), when oil hit a record $144/bbl
• China's prices are also at records. The government capped them in 2008, to avoid social unrest during the Olympics. Today, gasoline is at Rmb 9630/t and diesel at Rmb 8810/t, compared to June 2008's peaks of Rmb 6980/t and RMB 6520/t

China's gasoline price for 90 RON is thus $4.60/US gal ($1.20/litre), compared to current US prices of $3.75/gal. European prices are even higher at $8.00-$9.00/US gal.

Wages have not gone up to reflect today's record prices. And unemployment is considerably higher in most countries than back in 2008. So it is hardly surprising that ordinary people are cutting back on everything but real essentials.

Every policymaker should have a version of Bill Clinton's slogan hung in their office, to remind them of the crushing burden this imposes on the economy. "Its the oil price, stupid!".

Chemical markets continue to paint a very worrying picture of the state of the global economy. There has been no improvement in demand over the past week, since the blog first raised the alarm. Instead, plants are being temporarily closed because of the slowdown. Lanxess, for example, announced the closure of two plants in Belgium and the US, saying:

"Soft underlying demand in the second half of 2012 has continued into 2013 across most businesses, against the usual seasonal trend"

The blog has been in the industry since 1978 and it can't ever remember plants closing for lack of demand in March. Normally, this is one of the 4 strongest months in the year.

The news came, of course, in a week when the US Dow Jones Index hit an all-time record high. In the past, financial markets were often good indicators for the economy. But they have lost this role in recent years as central banks have mistakenly tried to pump up prices via liquidity programmes, in the belief this would support the real economy.

Instead today, as a result of these policies, no single market knows what it is pricing. So if and when financial markets finally realise that the real economy is back in recession, the upset could be considerable. It is therefore critical that management teams now develop a detailed contingency plan in case the following downside scenario emerges, perhaps as soon as Q2:

• Demand remains very slow, and producers cannot pass through today's higher crude oil prices
• Consumers have no need for spot purchases, and find it difficult to take their contract volumes
• More temporary plant closures start to occur
• Financial markets start to panic, as they realise today's record levels have no relation to reality
• Oil prices suddenly appear grossly over-valued
• Finance directors worry about working capital exposure and try to reduce inventories
• Declining oil prices add to this trend, as companies destock down the value chain

The chart highlights the risks, using BP price data. This shows oil prices in $2012 money (green) are at levels only seen during the OPEC crises, and in the early 1860s when exploration began. In view of its importance, the blog will return to this subject on Wednesday, and look in more detail at oil market developments in China and Europe since 2008.

Benchmark price movements since the IeC Downturn Monitor's 29 April 2011 launch, and latest ICIS pricing comments are below:
Naphtha Europe, down 16%. "Gasoline demand is still reasonable for certain grades but petchem demand is again limited"
PTA China, down 16%. "The market outlook remains largely bearish"
Brent crude oil, down 11%
HDPE USA export, down 10%. "Some older product, purchased at lower December price levels is appearing in the market and causing global buyers to anticipate lower prices"
Benzene NWE, down 3%. "Market started to soften as Asia saw a sharp drop in pricing, which was subsequently reflected in the US as well"
S&P 500 stock market index, up 14%

Jiang Zemin never spent too much time worrying about Western financial markets or domestic criticism, either before or after he became China's president between 1993-2003. Instead, he focused on 3 core areas, which became known as the Three Represents:

"The Party must always represent the requirements of the development of China's advanced productive forces, the orientation of the development of China's advanced culture, and the fundamental interests of the overwhelming majority of the people in China."

Today, it is unlikely his protégés on China's new politburo will deviate from this direction.

Equally, the new leadership needs to make unpopular but essential moves quickly whilst it retains the advantage of a honeymoon period. As the World Bank warned a year ago:

"Over the past half-century, many countries have entered middle-income status, but very few have made the additional leap to become high-income economies. Rather, several faced sudden, sharp decelerations in growth and have been unsuccessful in addressing the root structural cause of the slowdown."

PVC markets provide a good example of the key issues. As the chart shows (based on industry and Global Trade Information Services data), the previous Hu/Wen regime panicked in 2008-9 as China's export-led growth came to an end. Instead, they stimulated construction and housing markets, whilst also continuing to increase China's own PVC production capacity:

• Total PVC demand jumped 24% between 2008-10 whilst local production rose 31%

• Demand has however stagnated since then, rising only 5%
• Production has continued to rise, however and is up 14%
• Net imports have taken the strain, falling 38%

As with polyethylene, NAFTA's major cost advantage has only mitigated its position, with net imports up just 6% between 2010-12. By comparison, Europe's net position declined from 125KT in 2009 to 15KT, whilst NEA dropped from 890KT to 589KT and SEA from 244KT to zero.

The new regime cannot expect construction to support future growth, as the population ages. So its moves to burst the housing bubble, as discussed last week, are risky but inevitable.

Equally, as the doctrine of the Three Represents suggests, its new focus will surely be on raising living standards for the majority of the people, who earn <$10/day, and not on Hu/Wen's failed dream of building a western-style middle class during their decade in power.

My words fly up, my thoughts remain below:
Words without thoughts never to heaven go

These lines from Shakespeare's most famous play, Hamlet, aptly describe the critical issue in the Eurozone crisis.

This issue is very simple, as the blog discussed last July. Monetary union and a common eurozone currency cannot exist without political and economic union. This was clearly recognised at the start of the eurozone project in 1990. But nothing has since been done to make it happen.
Instead, we have had empty words. The most famous recent example was Mario Draghi's July statement that the European Central Bank (ECB) would "do whatever it takes" to save the euro. This statement meant nothing, however as it had not been agreed with Germany - who as Europe's richest country would ultimately have to pay the bill.

Now, the lack of substance is starting to be exposed. Germany faces elections in September, and public opinion will not allow many more late-night compromises in Crisis Summits to be achieved. The current argument over Cyprus is just the latest example of the problems that are now building up. Equally, whilst Germany can afford modest help for the smaller PIIGS countries such as Portugal, Ireland and Greece, it can't support large economies such as Italy and Spain.

And, of course, others can also play with words to have an effect. Thus Beppe Grillo (pictured), who now controls the largest party in the Italian Senate, has told the German paper Handelsblatt that he intends to call an online referendum to take Italy out of the euro.

He added that once out, he would then devalue the Italian lira. Presumably he would also propose legislation to ensure Italy did not have to repay all of its current €600bn borrowing - much of which now comes from Draghi's ECB, as many private lenders have withdrawn.

This, of course, is currently words too. But German voters may well not like the thought that Germany, as the ECB's paymaster, might end up paying €bns to cover losses on Italian loans.

The message is clear. In the end, as Shakespeare knew, it is actions and not words that count. Europe's politicians must urgently move beyond words and towards full economic and political union. If they continue to avoid the issue, then the collapse of monetary union and the euro will become increasingly likely.

Xi Jinping was formally confirmed as China's new president this week. But we know remarkably little about him, apart from a rather dry list of his official positions as he climbed the career ladder. This is understandable, given the chaos that resulted from Mao's personality cult and the Cultural Revolution.

However, we do know something about Xi's father, Xi Zhongxun, who died in 2002 at the age of 89. He was purged 3 times by Mao, despite being a Party member from 1928 and one of those who welcomed Mao at the end of the Long March. Thus although Xi Jinping is now called a 'princeling', his upbringing was hardly privileged. His father spent 16 years in jail - half in solitary confinement.

The blog only came to know of Xi Zhongxun much later, when it was helping to lead ICI's Asian business development activities between 1987-92. The connection was that Xi had been sent in 1978 to run Guangdong province (next door to ICI's Asian HQ in Hong Kong), after having been rehabilitated once Mao died.

It was very clear to us that Xi was completely different to most other Party figures. Most notably, he asked previously unasked questions - as Robert Kuhn's book 'How China's Leaders Think' describes. Kuhn notes that "Xi wondered why, if 80% of Hong Kong's population was from Guangdong, was Hong Kong so developed and Guangdong so backward?"

Xi's answer was potentially still heresy at the time, as he concluded that the difference was not geography or people, but the system. And so in 1979 he persuaded the Central Committee to make Shenzhen and Zhuhai (then typically backward villages) into 'Special Economic Zones', so they could "explore the new road" for economic development.

Xi also made no compromises on the road to modernising Guangdong's economy. As he told his team, "To develop, we have to change. We have to do it even if we have to lose our lives. Comrades, let us work hard". And within 10 years, he had created 10 cities to rival Hong Kong, where none had existed before.

Xi Jinping may or may not be like his father. But as the blog noted in April 2010, he was the first senior Chinese leader to recognise that the era of export-led development was over and that instead:

"We must develop the economy mainly by relying on the domestic market and attach great importance to domestic demand, especially consumption demand, in driving economic development."

He has an exceptionally difficult task ahead, perhaps even more difficult than his father's. He has to change the whole direction of China's economic development. All of us, and not just China, will suffer if he fails. The blog therefore wishes him well.

The blog was with the mining industry last week, when giving the keynote speech on The Impact of the 'Demographic Cliff' on Demand Patterns at the annual Metal-Pages conference. Mining is seeing similar demand patterns to those in chemicals, whilst the price performance of aluminium shows very similar influences to those at work in oil markets, as the above chart of developments in the LME aluminium price since 1993 shows:

• Prices ranged between $1000 - $2000/t from 1993 until 2005, just as oil prices ranged between $10 - $30/bbl
• They then shot up to peak at $3000/t in 2008, whilst oil rocketed to $145/bbl
• After collapsing in Q4 2008, both have recovered to trade above historical levels

Aluminium is, of course, of great interest in its own right, and as a critical use for caustic soda.

There have been 2 key developments in aluminium markets since 2009. The first was the expansion of China's demand until 2011. The second has been the enormous growth in the role of financial players. The former is well understood, but the latter is quite remarkable:

• Bloomberg report that stocks are now at record levels and are expected to keep rising in 2013 to reach 8.67m tonnes. This is enough to build 62m cars (total annual world volume)
• Production is expanding rapidly due to the high prices, and is well ahead of demand
• The reason is that 80% of all aluminium stocks are locked into speculative financial contracts, and so are unavailable for use by genuine consumers
• This volume has overwhelmed warehousing operations at the major exchanges such as the London Metals Exchange. Buyers usually wait a year to obtain supplies
• Reuters has reported that the wait is deliberate, as the major warehouses are owned by companies such as Goldman Sachs and Glencore - who profit from high storage fees

All this is, of course, completely legal within the LME's rules.

Aluminium is thus another example of the way in which global financial markets have totally lost their true role in enabling price discovery. Instead, they have become a speculative tool for those with access to low-cost central bank liquidity.

The situation can clearly not continue forever. But for the moment, end-consumers have no choice but to pay today's high prices. Similarly, when the party does eventually come to an end, companies (including chloralkali producers) will suffer major losses on inventory values. Whilst operating rates may well crash until the stock overhang is worked down.

Financial markets long ago lost all touch with reality. Not only have central banks provided $tns of cheap liquidity with the specific aim of pushing stock markets higher. But they have also allowed computers to dominate trading, so no single market now knows what it is pricing.

Chemical markets, and those who operate in them, have no such silver lining. They have to deal with the results of these policies - namely higher oil prices and very weak demand.

The blog has been travelling a lot in recent weeks. And everywhere it has been, it has asked the same question: "This should be one of the strongest periods of the year for demand. What are you seeing?" Uniformly, the news has been shockingly bad:

• One board member said on Monday that current performance was so bad, he had talked to his chairman over the weekend about emergency plans
• Nobody in the audience at Thursday's ICIS PET conference was seeing good demand
• Fellow-blogger John Richardson confirms the same picture for the Asian region

The blog's IeC Downturn Monitor is also clearly warning that major problems may lie ahead in Q2. As the chart shows, every single physical product in the portfolio is now falling in price. Only the US S&P 500 stock market index is still convinced sunny times lie ahead.

The blog has no crystal ball to forecast what may happen. But in response to an audience question on Thursday, it outlined a possible outlook for the next few weeks:

• Demand in the real economy remains weak as we head into Q2
• Companies start to report what is happening to astonished investors
• Cries go up for more stimulus, immediately
• Financial markets make one final rally as more liquidity is supplied
• Then, perhaps in May, reality can finally no longer be ignored
• Investors realise they have been living in a bubble, and rush for the exits
• Oil and other financial market prices begin a serious retreat

This pattern would tie in with the outlook of stock market historian David Schwartz. Writing in Saturday's Financial Times, he warns:

"A scan through the record book finds 12 occasions since the first world war when the UK stock market advanced very strongly in the first two months of the year. The aftermath of those rallies was sobering.

"The only time when shares escaped the curse of a sell-off after a powerful January-February rally was 1986. The stock market continued to rise for another month and then traded sideways for the rest of the year." (Markets then suffered 1 day falls of 25% in October 1987, blog note)

If your management team has not yet developed a contingency plan for a Q2 downturn, please start to prepare one now. There may be very little time left.

Benchmark price movements since the IeC Downturn Monitor's 29 April 2011 launch, and latest ICIS pricing comments are below:
PTA China, red, down 17%. "Polyester producers enhanced price promotion this week in a bid to relieve inventory pressure."
Naphtha Europe, dark brown, down 17%. "Tightness is easing in the market as a result of closed outbound arbitrages and subdued petrochemical demand"
Brent crude oil, blue, down 13%
HDPE USA export, purple, down 10%. "Almost no global demand for exports"
Benzene NWE, green, down 3%. "Values showed signs of volatility throughout the week"
S&P 500 stock market index, brown, up 14%

Are you worried about the economic outlook for your company, for your family and for your country? Do you suspect that current policies may be doing more harm than good? Are you interested in exploring a new analysis that focuses on the importance of people, rather than the results of computer modelling?

Over the past 2 years, the blog has found an increasing number of people are saying 'yes' to all three questions above. With co-author John Richardson, it has had the privilege of speaking to thousands of people around the world about the ideas in its new eBook, 'Boom, Gloom and the New Normal'. Without exception, they have been enthusiastic and supportive.

In the age of Twitter and news sound-bites, there is enormous pressure to condense key ideas into simple messages. But sometimes there is a need to explore new concepts in more depth, and to have time to reflect on them in a quiet moment.

Today, the blog is pleased to post a 30 minute video of its keynote presentation last week on the subject of 'Sustaining Growth as the West Arrives at the Demographic Cliff'. This was professionally produced by Metal-Pages, and webcast live during their conference. It explores:

• Why economic growth will be much slower for the next 20 years
• Why interest rates will also continue to remain low in the major economies
• Why policymakers are addressing the wrong issue when they worry about deflation
• Why China cannot possibly replace the demand being lost in the West

I hope you find it valuable and thought-provoking. Please click here to view it on YouTube.

Autos are the largest manufacturing business in the world, and are also the largest single source of demand for chemicals and plastics. So developments in the major markets are key to future economic growth and demand patterns.

The chart summarises developments since 2008 in the 7 major markets, which account for 85% of global volume, using national auto and Scotiabank data. Overall, sales grew 19% from 52m to 63m over the period, but performance in individual markets has been dramatically different:

• China (red line) has become the largest market, doubling sales to 14.7m
• The USA (black) has been volatile, but sales were up 9% overall
• The EU (purple) was once the largest market, but sales were down 13% overall

• Japan (green) was also volatile due to the tsunami tragedy, but sales are up 8%
• Russia (orange) has been very volatile, with sales up just 1%
• Brazil (brown) surged in 2008-10 but then slowed, with sales up 27%
• India (blue) also surged before plateauing, with sales up 33%

Overall, therefore, the industry has become very dependent on the Asian market for growth. It is now 40% of the global market, compared to 29% in 2008, with sales up 64% from 15m to 25m.

By comparison, sales in the major Western markets of N America and the European Union are now 46% of the global market, compared to 56%. And overall, sales have actually fallen 2%.

Two conclusions stand out from this analysis:

• Asian sales are most unlikely to maintain recent growth levels. China's new leadership has set tackling pollution as one of its main targets, and autos are a key contributor to this. Whilst India's market is now declining for the first time in a decade. Brazil and Russia are being similarly impacted by the slowdown in their major trading partners in China and the West
• Western sales will likely be stable at best over the next few years. Ageing consumers no longer need to drive so much, as they retire from work and the trips to shopping malls become less frequent. Equally, the markets are now mainly replacement-based, as young people are not only fewer in number but also appear to have less interest in buying new cars

So overall, growth is likely to be very slow. It could even be negative for a period if China really does get serious about rebalancing its economy in favour of the 80% of the population who earn less than $10/day. But this does not mean there are no opportunities for companies prepared to refocus on business model and technical innovation.

Low-cost cars, such as Renault's Dacia range and Nissan's planned $3k Datsun launch will likely start to dominate the mass market. Whilst car-sharing models, such as Mercedes' Car2Go service, will aim to provide mobility without the hassle and cost of full ownership.

There really isn't very much to say about the latest EU auto sales data. They were simply awful. As the chart shows, 2013 volumes (red square) are well below 2012 levels (green line). Less than 800k cars were sold in the 2 months combined, down 10%.

Some major markets have now been falling for a long time. But Spain was still down 10% versus 2012, whilst Italy was down 17%. Sales in the formerly stronger markets now seem to be following this pattern. France was down 12%, whilst Germany was down 11%. Only the UK of the major markets is still showing growth, up 8%.

The EU downturn really took hold over the summer, after a period where stronger markets such as Germany and France had helped to balance weaker sales in Spain and Italy. Thus the market went from being down 3% in June versus 2011, to being down 11% in September. Since then it has been down 5%, 10%, 16%, 9% and 11% in October, November, December, January and February respectively.

March is seasonally always the strongest market. If that does not shows signs of recovery, then the outlook for the rest of the year is likely to be bleak.

350k Americans are now reaching the age of 65 each month until 2030. But according to government forecasts, this surge in the retirement population will have little impact on economic growth. That's the view of the White House Council of Economic Advisers, which has just given its latest forecast for the impact of the ageing population on consumption:

"What will the aging population mean for consumption"? "More spending on health care and housing, less on education and transportation, but the changes will be small".

This is the top forecasting body in the country. But plainly it hasn't studied official Bureau of Labor Statistics data, which clearly shows that spending declines quite dramatically once people enter the New Old 55+ generation. As the blog discussed in October, this decline matters enormously, as household consumption is 71% of US GDP.

Even worse, is that this complacency means nothing is being done to plan for the impact of increased life expectancy. As the above chart from the Wall Street Journal shows:

• Life expectancy at age 65 is now 20.5 years for men and 22.7 years for women
• Yet only 13% of Americans are now 'very confident' they will have enough money in retirement
• 28% have 'no confidence' they will have enough money

So exactly how are these people going to maintain the same level of expenditure as when they were working?

Equally important, as we discuss in Boom, Gloom and the New Normal, is that more and more BabyBoomers have been leaving the Wealth Creator 25 - 54 cohort since 2000. This cohort does the 'heavy lifting' for economic growth as people settle down, have kids and build careers.

Instead, 82m Americans (26% of the population) now belong to the New Old 55+ cohort. This is a major change from the 21% level seen in the SuperCycle years from 1980 onwards. And by 2030, almost one third of the US population will be in the New Old.

New Olders only need to buy replacement products, as they already have most of what they need. They also have to focus on real 'needs', rather than 'wants', as their incomes decline as they reach retirement. So governments are fooling themselves, and everyone else, if they continue to assume that an ageing population will have no impact on economic growth.

Official forecasts for a return to strong SuperCycle levels of US economic growth are thus wishful thinking, not reality. Companies who believe them have a nasty shock ahead.

Readers outside Southern Europe may not realise the growing crisis that is developing across the region. As Unilever CEO Paul Polman warned in January, "the biggest issue in Europe is going to be social cohesion". Similarly, his colleague, Jan Zijderveld, European head, warned back in August that "poverty is returning to Europe". Zijderveld also highlighted how they were successfully introducing business models from "Indonesia (where) we sell single packs of shampoo for 2 to 3 cents and still make good money".

Senior Reuters editor Paul Taylor has just produced this excellent summary of the issues. Exceptionally, he has allowed the blog to reproduce it in full, with the permission of the author. As he notes, the whole post-War fabric of Europe, built at such cost, is now under threat. It is an important reminder of the fact that the crisis is far from being solved and is, in fact, steadily getting worse.

18 ‎March ‎2013, ‏‎20:39:26 | Paul Taylor
PARIS (Reuters) - Grigoris Lemonis, a 73-year-old Athens pensioner, uses his €580 ($750) monthly state pension to support his wife and the family of his son, an unemployed cook with two small children and a wife who works occasionally as a cleaner. Three-generation families surviving on a single income are increasingly common across southern Europe as mass unemployment tears at the fabric of closely knit societies.

The continent's social shock-absorbers are creaking under the strain of a prolonged economic crisis that began in 2008 and engulfed the euro zone in a sovereign debt crisis from 2010. The welfare state that Europeans built after World War Two, and which many view as a defining achievement of their civilisation, is one reason why the Great Recession has not triggered a revolution or severe social unrest so far.

"Daily life has become pure misery," said Lemonis, a former painter in the construction industry who owns his own house. "We are up to here with bills and once all that is paid there's nothing left to live a decent life," he said, adding that the family can only afford meat once or twice a month.

With more than 26 million unemployed in the 27-nation European Union, including nearly 6 million young people, the system is struggling, and in some places failing, to cope. Many of the jobless have exhausted their benefit entitlements. "In many countries, the poor are getting poorer," says Laszlo Andor, the EU's Commissioner for Employment and Social Affairs, pointing to a growing North-South divergence. "Europe's social fabric is clearly under pressure and a stronger response at EU and national level is needed."

Social spending rose across the continent in the first phase of the crisis but states like Greece, Portugal, Ireland, Spain and Italy that were hardest hit have now had to cut outlays on pensions, healthcare, education and unemployment benefits. Countries that target social spending towards providing services such as childcare, vocational training, job-search assistance and accessible healthcare have better results than those that spend most in cash payments to pensioners and the unemployed, Andor told Reuters in an interview.

While Austria and Spain both spent about 15 percent of GDP on social welfare other than pensions, Austria achieved a 55 percent poverty reduction while Spain managed only 28 percent. Countries like Italy and Poland that spend a higher share of their social budget on pensions tend to be less effective in alleviating poverty because the working-age population most severely hit by the crisis is less well covered, Andor said.

But welfare systems breed their own interest groups and are fiendishly hard to transform.

AFFORDABILITY
Political leaders are fretting about the affordability of the European social model in an era of high public debt, low growth and ageing populations. "If Europe today accounts for just over 7 per cent of the world's population, produces around 25 per cent of global GDP and has to finance 50 per cent of global social spending, then it's obvious that it will have to work very hard to maintain its prosperity and way of life," German Chancellor Angela Merkel said in an interview with the Financial Times last December.

Social spending as a proportion of output is now at least 6 percent higher than in 2007 on average in the 34 countries of the Organisation for Economic Cooperation and Development, a club of industrialised democracies of which 21 are EU members. Moreover, ageing populations are set to drive up the costs of pensions and healthcare in coming years, the OECD said.

The majority of EU governments have used the crisis as a reason to raise the retirement age, bringing it more into line with increasing life expectancy, said Willem Adema, an OECD expert on employment, labour and social affairs. Social scientists distinguish three broad welfare models: Nordic, continental European and Anglo-Saxon.
Nordic countries offer a high level of "cradle to grave" welfare with an emphasis on pre-school childcare and education, designed to keep women and older people in the labour market.

The continental European model features contributory social insurance systems that offer strong protection to "insiders" with protected jobs, while continuing to regulate employment and the labour market. The Anglo-Saxon model tends to make welfare payments smaller and more selective and encourages private provision of healthcare, education and pensions for the better-off.

The Nordic model seems to have proven the most effective at reducing poverty without discouraging people from work, although it comes with the highest taxes. Britain and Ireland pay cash allowances to stay-at-home single mothers, contrary to the OECD and EU view that such money is better spent on providing public childcare. In Germany, Merkel's government plans to introduce such a benefit this year.

"It makes more sense to get people into work than to focus on paying benefit to stay home," the OECD's Adema said. "Yet amazingly, some countries are cutting pre-school childcare." European governments have found it easier to trim welfare systems at the edges than to reform them radically. In particular, spending more on young children and school-leavers to promote employment and skills and less on the elderly is politically difficult. Older people vote more than the young.

"In many countries, it is the middle class who are the direct beneficiaries of social security entitlements," policy analysts Patrick Diamond and Guy Lodge wrote in a paper for the Policy Network think-tank. "This makes pensions and welfare payments to older cohorts practically untouchable." The Netherlands, where retirees enjoy the highest purchasing power in Europe, provides an example. Its recently created 50PLUS party that campaigns on behalf of pensioners won two seats in the 150-member parliament for the first time last year.

Since the new coalition of centre-right Liberals and the centre-left Labour party agreed to raise the retirement age to 67 from 2021, support for the grey movement has soared. A poll this month showed 50PLUS would win 18 seats if the election were held now, making it the third biggest party.

Older voters may fight their political corner, but they also should grasp the need to leave resources for social spending for the young. Just ask Lemonis - the Athens pensioner supporting two younger generations on his dwindling monthly allowance. "At least we pensioners are old and we've lived our lives," he said. "I'm worried about our children. What will they do when we can no longer help them?"

The blog was in sober mood when giving its usual New Year Outlook in January, warning that "renewed global recession appears to be the major risk facing us at the start of 2013". Developments since then only reinforce its caution. Europe and Asia are now seeing widespread weakness in demand:

• In Europe, the chairman of German major Lanxess, Axel Heitman, warned last week that "Q1 demand is poor and we expect only a slight increase for Q2". "Typically", he added, "we have very strong first and second quarters with around 60% of our EBITDA being generated in H1".
• In Asia, there has been no rebound after Lunar New Year. India looks worst impacted with Mitsubishi delaying the restart of its 800kt PTA plant at Haldia due to lack of demand. Several producers have also felt forced to introduce price protection policies to support sales
• In both regions, it also appears that many plants are operating at very low rates. in addition, it seems that increasing numbers of plants are taking unannounced 'maintenance shutdowns' as inventories build up.

So far, the US appears stronger. But the blog has always worried that today's apparent recovery has been heavily influenced by political developments, with the administration naturally doing everything it could to support the economy in the run-up to last November's presidential election. And Q1 railcar loadings, "the best real time indicator of industry activity" according to the American Chemistry Council, are down 1.4% versus 2012.

Q2 could be very difficult indeed, if today's lower level of demand continues. January and March are normally 2 of the 4 strongest months in the year. Yet as the chart above shows, prices for the products in the blog's Downturn Monitor portfolio are all now falling quite sharply.

Yet financial markets continue to assume 'all is for the best, in the best of all possible worlds'.

US inventories rose by an astonishing 1% in January (twice the expected amount, according to Bloomberg). Yet this was taken as a sign that companies was stocking up ahead of an expected boom. More likely, however, it indicates that sales were actually much lower than expected.

This is further confirmation, if any were needed, that oil and western stock markets have lost their essential role of price discovery. Instead they are being carried along on a flood of central bank liquidity. The moment when they reconnect with reality could well be very painful.

Benchmark price movements since the IeC Downturn Monitor's April 2011 launch, and latest ICIS pricing comments are below:
PTA China, red, down 18%. "Prices remained on a downtrend on the back of a slowdown of downstream polyester demand
Naphtha Europe, dark brown, down 18%. "Demand from the petrochemical sector is poor"
Brent crude oil, blue, down 13%
HDPE USA export, purple, down 11%. "Price reductions are related to a noticeable decline in demand, and the perception of high inventories throughout the chain"
Benzene NWE, green, down 4%. "Activity remains subdued amid bearish macroeconomic conditions and poor demand from key derivative sectors"
S&P 500 stock market index, brown, up 14%

China's new premier, Li Keqiang, was the first senior official to confirm that the country's GDP figures were "for guidance only", being "man-made and therefore unreliable". As he told the US ambassador in 2007, he instead used electricity consumption and bank lending (plus rail cargo) as his key indicators. It therefore seems appropriate to mark Li's appointment this month by reviewing the latest data. As the chart shows:

• Lending (red column) and electricity (green line) had the usual strong start in January
• But both dipped sharply in February. This seems more than just the effect of Lunar New Year
• Electricity consumption was down 12.5% versus 2012, and the lowest since February 2011
• Combined January/February consumption was thus only up 5.5%

Electricity consumption has proved a good proxy for real GDP growth in the past. And now a senior official has confirmed that those expecting a major new wave of stimulus spending are likely to be disappointed.

Liu Shijin, deputy director of the State Council's Development Research Center, warned on Sunday that "some may think the economic growth has bounced back from the bottom since the fourth quarter last year and will regain high-speed growth above 9 percent - but they are too optimistic." Instead, he described the recent economic bounce as only "temporary".

Another senior official, Zhu Zhixin, deputy director of the National Development and Reform Commission, made the new leadership's position even clearer. He stated that "the pivot point is to guarantee housing for subsistence needs, or the housing demand from low-income citizens". And he added that whilst the government regards construction as a core pillar for the economy, "China does not regard its property market as a pillar sector".

More signs are thus emerging that major economic reform is underway. Hence 1993's leadership transition may well provide a useful parallel for today's policy changes. Then president Jiang Zemin (kingmaker in the recent politburo appointments) and economics minister Zhu Rhonji initiated a major credit crackdown to curb speculation in the property market. Property prices dropped 40% in the major cities, and private sector GDP growth was just 3%.

Recent speculation in the property market has been on a much greater scale. Current prices in the major cities are twice as expensive in terms of earnings as in the US at the height of the subprime bubble. As Wang Shi, chairman of China's largest real estate developer Vanke, has warned "there are obvious bubbles in the property market, and it is possible it will get out of control and crack."

Whilst it will therefore be very painful to burst the bubble in the short-term, the risks of allowing it to continue could prove far worse.