China shows paper oil is cheap,physical isn8217;t: Clyde Russell

Signs of slowing manufacturing output in both China and Germany have added to fears that recession is inevitable and it8217;s time to rush for the exit of any asset leveraged to growth,such as oil and copper.

But this sentiment isn8217;t shared by physical commodity traders,who continue to report strong buying interest from China and India for oil,and ongoing Chinese demand for commodities including copper and coal.

Neither is it supported by Chinese trade data,which if anything,showed increasing strength in August as imports of key commodities gained.

And to cap it off,the physical prices of some Middle East crude also speak of ongoing strong demand from Asia.

The premium of physical Oman crude cargoes over the Middle East benchmark Dubai price jumped to its highest level in two years this week,reaching 2.25 a barrel on Thursday.

This shows that refiners in Asia are willing to pay more for cargoes than what the benchmark pricing suggests they should.

Put another way,the price of paper oil is falling at a faster rate than that for actual oil.

Another telling factor is that Saudi Aramco,the world8217;s biggest crude exporter,saw fit to increase the premiums it charges Asian customers for October deliveries.

Not only are the Saudis lifting prices,they are shipping full volumes,hardly a sign that demand is about to fall off a cliff,despite all the gloom over the global economic outlook.

Given that so much of the commodity outlook is dependent on China,it8217;s worth looking at what has been happening so far this year.

There is no doubt that oil imports into the world8217;s second-biggest consumer went through a soft patch around May and June,but they have since been recovering fairly strongly.

August imports stood at 4.95 million barrels a day,up 0.7 percent from a year earlier and the likelihood is that they will continue to increase for the rest of the year as refineries finish maintenance and new units are commissioned.

It is also now evident that the Chinese curbed their crude buying after prices reached highs for the year around April,when New York futures rose to 114 a barrel.

With prices now some 30 percent lower,it stands to reason that the Chinese will resume buying to rebuild stockpiles,both commercial and possibly strategic.

China no longer provides details of its oil inventories,but the International Energy Agency makes an estimate based on reported percentage stock changes for commercial stockpiles.

This shows that commercial crude inventories stood at 221 million barrels in August last year,before dropping to 202.9 million barrels in May this year.

Perhaps it isn8217;t a coincidence that the decline in inventories happened shortly after prices reached their peak for the year.

Since then,stockpiles have recovered to 216.3 million barrels in July,and it won8217;t be surprising to see this number rise further as inventories are built up for new units and as Chinese refineries take advantage of declining prices.

Similarly it won8217;t be surprising to see copper imports into China gaining. While August imports of refined copper were still down about 12 percent year-on-year,they jumped 21 percent from July.

Part of this can be put down to a more attractive arbitrage between London and Shanghai,but also strong demand has meant stockpiles have been depleted over the first half of 2011.

Again,like oil,Chinese buying slowed when prices were high,so the chances are it will gain now that copper has been sold off.

The Chinese have shown they are very much like Warren Buffett: they like things on sale.

And,if you are a glass-half-full type of person,the HSBC flash China PMI does confirm that manufacturing growth is slowing,but not so dramatically that a hard landing is likely.

But right now,any positive news on actual demand for commodities is being swept away by the flood of worries over Greece,the rest of Europe and the United States.

Assuming,and I acknowledge this is now a more risky assumption than it was a few months ago,that Europe manages to muddle through the debt crisis and the United States achieves even tepid economic growth,then the outlook for commodities remains one of fairly strong demand growth on the back of Asia.

The chances are that by the time investors in the Western world realise this,the Chinese will have been merrily buying away.

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