When did metals producers become too big to fail? These days, it seems every industry seeks protection. From its competitors, market conditions, and even from itself.
Industrials, or metals, are the latest in a line of industries crying out for help. But at what point is it acceptable to start bailing out metals producers? The way US authorities bailed out the banking sector following the global financial crisis?
Ask Chinese metal producers, and they’d tell you we’re well overdue.
Aluminium and nickel producers in China, facing weak market conditions, are requesting assistance from authorities. The industry is grappling with low prices, oversupply and slowing demand. In response, it’s asked the State Reserve Bureau (SRB) to purchase surplus metal reserves to ease pressures in the market. The Australian Financial Review reports:
‘The state-controlled metals industry body, China Nonferrous Metals Industry Association, proposed on Monday that the government scoop up aluminium, nickel and minor metals including cobalt and indium, an official at the association and two industry sources with direct knowledge of the matter said.
‘The request was made to the state planner, the National Development and Reform Commission. While it is not clear if the authorities will agree to the proposal, the approach underlines the extent to which loss-making smelters in the world’s top producer and consumer are suffering from prices hovering at or near multi-year lows.
‘One source familiar with the producers’ request said the China Nonferrous Metals Industry Association had suggested that the state buys 900,000 tonnes of aluminium, 30,000 tonnes of refined nickel, 40 tonnes of indium, and 400,000 tonnes of zinc.’
This wouldn’t be the first time something like this has taken place. In 2009 there was a similar attempt to arrest sliding copper prices. At the time, the SRB agreed to purchase up to 700,000 tonnes of copper.
Copper was trading at US$3,000 a tonne at that point. With the SRB’s help, copper prices stabilised. The move is viewed by some as a key factor in helping push prices up to US$10,000 a tonne by 2011.
Only difference now is that Chinese authorities view copper as a metal of strategic importance. Which can’t be said of aluminium or nickel.
What’s more, metal prices are in arguably worse shape today than in 2009. Aluminium is down by almost 30% since this time last year. Nickel is trading at 12-year lows, falling to US$8,145 per tonne this week. The last time it dropped below this level was in 2003. So the SRB would probably have to foot a larger bill this time around.
In any case, these figures speak volumes about the dire state of the industrial sector. Not just in China but across the world too. Yet it’s all part and parcel of the forces dragging on global growth at the moment. We could easily apply it to any other industry. Australia’s own struggle with weaker commodity prices reflects slackening global demand.
Metals producers and banks, two peas in the same pod
How is supporting metals producers any different to the bank bailouts? It isn’t. In fact the resemblance is striking.
The GFC crisis was a mess that banks created themselves. They lent to risky borrowers. They dabbled in too many dangerous products…many of which even traders didn’t understand. When the mortgage crisis blew up, the banking sector faced ruin. Lehmann Brothers was the highest profile casualty among the major lenders. But the rest got off with a slap on the wrist. And for what? The fear that a global depression would take root? US taxpayers bailed out the same banks that caused the mess. And were then told to clean it up or risk a major depression. It spooked the government enough to accept the bailout. Even if many had reservations about the bankers’ claims.
Bailing out Chinese metals producers is the same spin on an old story. These companies, like the banks, shoulder much of the blame for falling prices. That applies to the entire spectrum of the supply chain too. It includes Chinese metals makers. But it also accounts for metal producing commodities like iron ore.
From that perspective, the likes of BHP Billiton [ASX:BHP] and Rio Tinto [ASX:RIO] are accountable. They’re responsible for flooding markets with iron ore that leads to oversupply. The actions of both BHP and Rio affect metals producers significantly. That’s because Chinese producers can’t help but buy cheap commodities. Not when there’s market share up for grab. If you’re not buying and producing cheaper metals, you’re losing out to someone who is…producers that can sell-on those metals at reduced prices.
These market share strategies are as counterproductive as they sound. Demand for commodities and metals remains weak. And yet, producers persist with maintaining high supply. It’s as if everyone knows they’re engaging in cannibalism, but can’t do anything about it. If you don’t play along, you risk going out of business altogether.
It’s this same mindset that caused the banking crisis too. Banks engaged in risky trading and lending because everyone was doing it. They were all gorging on the same carcass. Not doing so risked a potential loss of market share. Or large bonuses in the case of bankers…
Yet even if banks received their bail outs, they were never too big to fail. They just convinced everyone they were. Chinese metal producers could do the same. In China, industry lobby groups carry a lot of influence. In a country that’s sensitive to changes in labour markets, that’s no major surprise. It can convince authorities that doing nothing will result in widespread unemployment. A fear of mass unemployment tends to work when other persuasive techniques don’t.
China should take this opportunity instead to make an example. Not everyone can, or should, survive in a struggling market place. And producers should live with the consequences of forcing up supply under the guise of maintaining market share. Even if it means some producers going out of business. Uncompetitive producers have no place surviving in a low cost environment. Inefficiency shouldn’t be encouraged, let alone supported.
In all probability, metals producers can expect some kind of help. China’s simply not mature enough to let industries flail for too long. Not when it’s trying to manage the delicate matter of its economic slowdown.
Unfortunately, state authorities often make allowances for under fire industries. Especially in instances, as in metals, where Chinese producers compete in a global marketplace. Because of this, we can expect metals producers to receive some kind of financial assistance from the SRB.
In the long run, the industry would be better off having its own Lehmann Brothers…or two.
Contributor, The Daily Reckoning
PS: Aussie mining sector stocks have taken a battering on the back of China’s slowdown.
The Daily Reckoning’s Vern Gowdie believes we’re going to see a catastrophic crash on the ASX.
Vern is the award-winning Founder of the Gowdie Letter and Gowdie Family Wealth advisory services. Vern’s ranked as one of Australia’s Top 50 financial planners. Not only does he predict a major crash, but he’s convinced the ASX could lose as much as 90% of its market cap. It’s already down 4.5% this year.
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