INDUSTRIAL COMMODITIES AND CHINA
Commodities by Chico
May 2, 2003

Much has been written about the ascendancy of China into the global economy. Key to this ascendancy is the growing necessity of China to import critical commodities necessary to fuel its economic growth.

China is ranked as the seventh largest economy in the world; however, based on a purchasing power parity calculation, China is already the second largest economy in the world, behind the United States but ahead of Japan. And it is also the fourth largest exporter in the world. Moreover, China is an economy that is growing rapidly – China has averaged growth of 9.5% a year since 1990, three times faster than the world economy average growth rate.

To many companies outside of China, not only in the Western world but also in nearby areas of South and East Asia, China therefore represents the future - as a huge potential customer to do business with or as a huge potential low-cost competitor of business.

As Marc Faber in his new book Tomorrow’s Gold points out: “Chinese economic and military influence is increasingly becoming a threat and at the same time, an opportunity…China is now also becoming Asia’s largest customer for its natural resource requirements.” And then later: “[China] will have a huge impact on the world’s commodity markets and is likely to push up commodity prices very considerably. In fact, I regard the purchase of a basket of commodities as the safest way to play the emergence of China as the world’s dominant economic power.”

And so the question now is which basket of commodities should one invest in to ride China’s growth?

As China grows, it is becoming not only a huge importer of commodities but also a huge exporter of commodities, and so an understanding of this situation is critical to successfully investing in commodities or in commodity-based companies.

China is now already a huge growing importer of a variety of commodities - for example agricultural commodities such as sugar, vegetable oils and coffee; and natural resources like oil, natural gas, lumber and pulp; and basic industrial commodities such as copper, nickel, iron ore, and lead. In this article, we focus on the industrial commodities.

China as Importer

Let’s first consider China as a huge importer. Here are some facts and trends:

Copper - Bloomsbury Minerals Economics, a London consulting firm, estimates that China’s use of refined copper grew at 21 percent in 2001 and 13 percent last year – placing it now ahead of the United States as the world's biggest consumer of copper. And Bloomsbury forecasts a further 10 percent rise in 2003, reflecting China’s rapid expansion of its electric power grid and growing demand for domestic appliances. Bloomsbury calculates that Chinese imports of copper have surged by an average of 37 percent a year since 1999, and are probably still growing at that pace.

Nickel – China accounted for two-thirds of the increase in global demand for nickel last year. Inco, one of the world’s largest nickel producers, told analysts recently that demand in China for stainless steel, which is made with nickel, has expanded so fast recently that the growth alone was equal to more than half of total consumption in the United States or Japan. Peter Goudie, Inco's executive vice president for marketing, said, "It is easy to understand why China has become such a dominant influence in nickel and across the full range of metals."

Iron Ore – China is now the world's second largest importer of iron ore.

In addition to copper, nickel, and iron ore, other key industrial commodities in which China is a net importer are alumina, gold, and platinum. Platinum is key as it is slated as playing a key role in the upcoming much talked about hydrogen economy.

China as Exporter

However, China is not only a large importer of commodities but also a large exporter of industrial commodities as well. This dichotomy is proving to be a critical determining factor in doing business with China.

It is to be expected that commodity-related companies outside of China that export commodities to China in which China is a net exporter will likely find it very difficult to compete with the low-cost operating and wage structure of similar Chinese companies. Alternatively, commodity-related companies outside of China that export commodities to China in which China is a net importer will likely find it very profitable to do business with China in riding China’s growth.

Case in point is Noranda, a Canadian mining group. Noranda, a unit of Brascan, and its partners spent 733 million Canadian dollars (US$496 million) to plan and build the world's largest magnesium smelting plant, located in Danville, Quebec. What has happened is that Noranda has written off its 80 percent stake in the new plant. The reason - Noranda says that the plant cannot be profitably run mainly because magnesium, a lightweight metal used mainly in the electronics, auto and aviation industries, is being heavily exported out of China. According to Richard Opatick, director of the International Magnesium Association in Washington, magnesium prices have fallen by half in the last three years. And, in addition to the Noranda plant, prices have forced the closings of the last two primary magnesium producers in Europe, one in France and one in Norway. And now, the United States and the European Union have moved to impose duties on Chinese-exported magnesium, claiming that China is dumping the metal on world markets at prices even below production.

China is sending ripples down other markets as well. David Humphreys, Chief Economist of Rio Tinto, has said that aluminum is “potentially another magnesium situation.” China has expanded from importing 132,000 tons of aluminum in 2001 to exporting about twice that figure last year. And according to Carmine Nappi, director of industry analysis at Alcan, a major producer of aluminum based in Montreal: "They can build a smelter in less time than us, and the cost is half that in the Western world."

The Breakdown

Therefore it is necessary to determine which industrial commodities China is a net importer of and which commodities China is a net exporter of. This then corresponds to the commodities in which China needs (net importer) and in which China does not need (net exporter). Knowing this can then lead an investor or company to determine its investment or development strategy. Here is table illustrating the breakdown of the current situation for Chinese industrial commodities. This table provides the key to determining which industrial commodities or industrial commodity-based companies to invest in to ride the massive growth of China:

Reference
Chief Economist of Rio Tinto, David Humphreys, “China-Threat or Opportunity” Salomon Smith Barney Conference Sydney 5 Dec 2002

© 2003 Chico
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