Natural rubber: how can higher prices be sustained absent higher demand?

by SR on October 5, 2012

Natural rubber price in US$ per kg

Go on, convince me the increase in the rubber price is sustainable

Conclusion: I would not lose sleep over the Japan tyre makers (e.g. Bridgestone, Sumitomo Rubber) because of higher natural rubber prices. The current rally in the commodity will likely be shortlived unless the China auto market turns around. However, if there are moves to stimulate the auto market in China or if demand picks up of its own accord, you should unload tyre supplier stocks. And buy China.

  • China auto sales drive natural rubber prices. I’ve argued many times that incremental demand growth for autos in China is the main driver of natural rubber prices (see this post or, for a more detailed explanation, this post). I believe this is caused by speculative buying from commodity funds. What is interesting about the natural rubber market recently (see chart at the top of this page) is that the price is rising without solid evidence of a recovery in the auto market in China. Dead cat bounce?

Rubber stocks at Shanghai Futures Exchange designated warehouses (monthly average, in tonnes)

  • Lower stocks of rubber don’t mean a shortage. Textbook supply and demand theory suggests that prices go up when demand exceeds supply and a recent Bloomberg article noted that rubber stocks are at low levels. Well, the chart directly above certainly shows that stocks of rubber in warehouses designated by the Shanghai Futures Exchange are at low levels, but that doesn’t mean that rubber is too scarce to stockpile. Natural rubber stocks are at low levels for two reasons. First, because auto demand is growing only slowly or not at all. Second, because there is plentiful supply and customers are not concerned about their ability to get hold of natural rubber quickly.

Natural rubber prices and stocks of natural rubber in China

  • Higher prices don’t mean a shortage either. The price of natural rubber can rise and remain high on speculative inflows of money even if there is plentiful supply. For example, in 2010 when rubber stocks in China were high, the price (around US$3.00/kg) was less than half the peak price of $6.00/kg that was reached in early 2011. Yet rubber stocks fell as prices rose and then remained at low levels. So rising stocks of natural rubber (and there has been a slight increase of late) do not necessarily a fundamental basis for higher rubber prices.

Year-on-year change in China auto sales vs rubber stocks held in China

  • So what drives rubber stockpiling? Growth in China autos. What drives stockpiling is the perceived rate of growth in demand for vehicles in China. The chart above shows that very clearly. Obviously there must be some kind of linkage between supply of natural rubber, stocks of natural rubber, natural rubber pricing and demand – that I do not deny. My argument is that the price of natural rubber can and does decouple from demand for rubber in the short term. What drives stockpiling is the perceived rate of growth in demand for vehicles in China. Depending on which market research you read, autos account for 50 to 80% of natural rubber demand in China, yet as the chart above shows, the year-on-year growth in China auto sales was slowing all through 2010 and growth did not pick up in 2011. Why then did the price of natural rubber move from $3.00/kg in early 2010 – when auto demand in China was growing at more than 100% YoY – to more than $6.00/kg in early 2011 when demand was flat and even briefly negative year-on-year? The 2011 rubber rally was an unsustainable bubble.

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