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Chinese Metals Demand:


Poised to Correct?
Authored By The Salida Capital Investment Team

August 21, 2009

This topical report is authored by the Salida Capital Investment Team on a monthly basis. Each report highlights a current
trend, theme or idea of significant interest that we are actively following. The majority of our investment funds are
fundamentally driven at the position level however our viewpoint on macro themes is instrumental in determining the
strategies and sectors we focus on to explore and uncover investment opportunities. Correctly forecasting and understand-
ing these macro themes has played an instrumental role in our long term successful track record and will continue to be a
critical element in how we manage investments going forward.

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Salida Special Report
Chinese Metals Demand: Poised to Correct? August 21, 2009

Market Outlook

A Sudden Bear Market in Chinese Stocks??? What Gives???

In the midst of all the euphoria and burgeoning optimism over global economic “green
shoots”, a funny thing happened. China, the world’s economic bright spot this year, has
suddenly seen its stock market tumble. And not exactly a mild tumble — a near bear
market plunge of 19.8% in a mere two weeks.

How can this be?

Shanghai Composite Index CRB Commodity Index


4,000 400

3,000 300

2,000 200

1,000 100

0 0
Jan 09 Apr 09 Jul 09 Jan 09 Apr 09 Jul 09

Source: Bloomberg Source: Bloomberg

Is the “China Story” Susceptible to a Near–Term Setback?

The aggressive fiscal and monetary measures undertaken by the Chinese Government
over the past several months have been nothing short of stunning. Its 4 trillion yuan
(US$586 billion) spending package has been well–documented, as has the country’s
highly accommodative monetary policy. Perhaps the most striking indicator of the
government’s efforts is the enormous growth in bank loans this year. Interest rates
were slashed, reserve requirements cut, and loan quotas abandoned. Beijing told the
banks to flood the economy with money — and the banks enthusiastically complied.
Through the first six months of 2009, Chinese banks made a whopping 7.4 trillion
yuan (US$1.1 trillion) in new loans — three times as much as in the first half of 2008
and considerably greater than the government’s full year target of 5 trillion yuan.
What credit crisis!!!

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Salida Special Report
Chinese Metals Demand: Poised to Correct? August 21, 2009

But enough is enough. Amidst concerns over soaring equities, commodities, and real
estate and the growing potential for serious bad loan problems, Chinese officials have
allegedly told the largest state–controlled banks to rein in the pace of lending.

And it looks like the banks once again are following instructions. July’s loan growth
was not only much lower than previous months, but was also down year–over–year —
the first such decline since last fall.

Chinese Banks’ Monthly Loan Growth (Trillion Yuan)


2.0

1.6

1.2

0.8

0.4

0.0

-0.4
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2006 2007 2008 2009 Source: People’s Bank of China

What happens if this tempering of loan growth continues? In June, economist Wei
Jianing of China’s State Council estimated (unofficially) that as much as 20% of new
bank lending had gone into stock speculation, and an additional 30% into the property
market. A sudden disappearance of easy credit could lead to a plethora of margin calls
and forced sales which could reverberate throughout Chinese stock and commodity
markets. Thus far (through June) Chinese copper imports have remained at lofty
levels. However, in recent days, the price of copper has quietly slipped about 5% from
2009 highs. Meanwhile stories continue to circulate about individuals and small
businesses in China having made leveraged bets on an ever rising copper price. Stories
also suggest that Chinese production of refined materials and intermediate products
continue to exceed demand as local officials frantically keep plants running in order to
keep GDP numbers up.

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Salida Special Report
Chinese Metals Demand: Poised to Correct? August 21, 2009

China Imports of Refined Copper & Alloys Copper Price


(’000t) (US$/lb)
400 3.00

300
2.00

200

1.00
100

0 0.00
Jan Apr Jul Oct Jan 09 Apr 09 Jul 09

2008 2009 Source: China Customs Source: Bloomberg

SHFE Copper Inventories SHFE Zinc Inventories


(’000t) (’000t)
75 120

90
50

60

25
30

0 0

Q1/09 Q2/09 Q3/09 Q1/09 Q2/09 Q3/09

Source: Shanghai Futures Exchange Source: Shanghai Futures Exchange

With tighter Chinese credit availability and growing inventories, could a material
correction in copper (and other metals) be looming?

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Salida Special Report
Chinese Metals Demand: Poised to Correct? August 21, 2009

Market Opportunity

To be clear, we remain steadfastly bullish on the China story in general and of


commodities in particular — at least over the intermediate to long term. However,
a combination of aggressive Chinese government intervention and leveraged
momentum buying among individual and institutional buyers alike has lifted metals
prices dramatically this year, with barely a pause. A sudden tightening of credit
availability could certainly prove the catalyst to a material sell–off in commodities held
in “weak hands”. The Chinese stock market has already corrected in rapid fashion.
Could metals prices be next?

While some may argue that a recovering U.S. and/or Europe could pick up the slack if
Chinese buying wanes, we are somewhat skeptical. Some restocking in the Western
world may indeed occur, but how aggressively? At prices near multi–month highs?
With major economies still struggling?

Infrastructure building is by nature highly metals intensive, and China will most likely
undergo a dramatic transformation in the years and decades ahead. So we have little
doubt that real demand will ultimately soak up tremendous quantities of copper and
other commodities. But it is also entirely possible that the market has moved too far
too fast. With the likelihood of tighter Chinese credit conditions, higher inventories,
and the always tense September–October period approaching, we feel that a more
cautious positioning is warranted for the near term. That said, we would not expect
an outright collapse or anything approaching last year’s carnage. Central banks
worldwide are still printing money aggressively and safe haven investments
(i.e. treasuries) are offering miniscule yields. As such we would look to boost exposure
to metals and other commodities on any material weakness. Buy the dips!

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Salida Capital was founded in 2001, and is a leading international alternative investment management firm
committed to providing innovative investment solutions that deliver superior absolute returns in the mid
to long term. Through a number of funds and separately managed accounts, Salida Capital offers world
class investment expertise, innovative products, disciplined investment strategies and a commitment to
transparency and service excellence.

Funds advised by Salida Capital

Salida Multi Strategy Fund — Inception: November 2004


canadian
Salida Strategic Growth Fund — Inception: Fall 2009

BTR Strategic Growth Fund — Inception: March 2009


international
BTR Global Energy Fund — Inception: January 2006

Past Reports

World Markets Watch April 2009


World Markets Watch May 2009
World Markets Watch June 2009
World Markets Watch July 2009
Special Report: Uranium Shortage Looming? April 2009
Special Report: U.S. Natural Gas: A Coiled Spring May 2009
Special Report: Cautious on Copper ... For Now June 2009
Special Report: Chinese Metals Demand: Poised to Correct? August 2009
The Energy Report June 2009
The Energy Report July 2009
The Energy Report August 2009

Salida Capital

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Phone: 416 849 2555 Toll Free: 866 213 0291 Fax: 416 849 2552
Email: sales@salidacapital.com

This report is published by Salida Capital Corp. (“Salida”). The information contained in this report does not constitute a recommendation by the authors or Salida
to buy or sell any of the securities, commodities, currencies or other financial instruments or assets discussed herein. This report has been prepared using information
from sources that the authors and Salida believe to be reliable, however neither the authors nor Salida guarantees the accuracy of such information. This report does
not constitute and may not be used for the purposes of effecting an offer or solicitation of shares of any “Salida” or “BTR” Funds (the “Funds”). Important information
about the Funds is contained in their offering memorandums, including a detailed description of the Funds’ investment objectives, investment strategies and risk factors.
Information in this report is qualified in its entirety by the relevant offering memorandum.