02 August 2011

China SignPost™ (洞察中国) #42–What if the China Housing Bulls Are Right? Assessing Potential Commodity Demand from Urbanization in China’s Top 10 Residential Markets, 2011-2019

Gabe Collins and Andrew Erickson, “What if the China Housing Bulls Are Right? Assessing Potential Commodity Demand from Urbanization in China’s Top 10 Residential Markets, 2011-2019,” China SignPost™ (洞察中国), No. 42 (2 August 2011).

China SignPost™ 洞察中国–“Clear, high-impact China analysis.”©

Summary:

–Chinese farmers are likely to continue abandoning tough and unprofitable farm work to seek their fortunes in cities across China.

–Land ownership reforms would also likely send waves of farmers into the cities in search of work.

–By 2019, the Economist Intelligence Unit estimates that the cities of Chongqing, Chengdu, Zhengzhou, Tianjin, Beijing, Xi’an, Changsha, Shanghai, Shenzhen, and Dongguan will see a net increase of roughly 4.0 billion m2 of housing space—more than 50% larger than the 2.6 billion m2 net increase that the entire U.S. market is expected to experience by 2020 (based on data from Macroeconomic Advisors and the U.S. Census Bureau).

–Our base case commodity demand analysis anticipates that housing construction in the 10 target cities between now and 2019 will use at least 967 million tonnes of cement, 313 million tonnes of iron ore, 232 million tonnes of coal, and 4 million tonnes of copper.

–This would mean annual iron ore demand roughly equivalent to the entire annual ore production of Cliffs Natural Resources, the largest North American producer, which says it expects to produce more than 38 million tonnes of iron ore worldwide in 2011.

–The 10 cities’ average annual cement demand in our base case scenario would be 35% larger than the entire volume of cement consumed by the United States in 2010.

China watchers, and investors in particular, increasingly fall into two major camps: the China housing bulls, who perceive substantial housing shortages that will keep prices up and drive construction; and the housing bears, who believe that Chinese property buyers have overextended themselves and that in the memorable words of prominent hedge fund James Chanos, the country is on an economic “treadmill to hell” driven by overinvestment in fixed assets. Time will tell whose view is more accurate regarding this globally consequential set of questions. That said, amidst the heavy focus on what China’s residential property prices are doing “this month,” or even “this year,” we believe it is important to:

1)      Look beyond 2011

2)      Consider that, among other factors, the fundamental inefficiency of Chinese agriculture is likely to continue driving farmers and their families into China’s urban areas

3)      Assess the attendant implications

China faces a double dilemma with respect to agriculture, which currently employs more than 35% of its workforce, according to the CIA World Factbook. First, the bulk of its farmers currently cannot compete with large, low-cost grain producers in the U.S., Brazil, Argentina, Australia, Russia, and Ukraine and are likely to continue abandoning tough and unprofitable farm work and seek their fortunes in cities across China. Second, the land ownership reforms necessary to make Chinese farming more efficient would fly in the face of the Party’s rural revolutionary history of “land for all” and would also send waves of farmers into the cities in search of work.

China’s level of urbanization remains quite low, even by developing economy standards, a fact that—taken in conjunction with the agricultural reform dilemma mentioned above—suggests that there remains substantial upside for movement into the cities. It also hints that the estimates that McKinsey and others make of the urban population in China growing by as many as 350 million people in total over the next 20 years are realistic.

China’s leaders do not want to see Mumbai- or Johannesburg-style shantytowns on the outskirts of Chinese cities, raising the question of how housing will be built to accommodate new arrivals, as well as current urban residents who may wish to upgrade their domiciles as incomes rise. This in turn raises the question of what level of raw material demand new housing additions are likely to create. …