Who is the predator and who is the prey? That is what we wonder today. Is China preying on BHP Billiton (ASX: BHP)? Or is BHP preying on Rio? Who are the barracudas and who are the minnows?
First, the big fish. "With iron ore prices rising explosively," says China's National Development Reform Commission (NDRC), "many domestic firms are very enthusiastic about investing in overseas mines, which needs strengthened macro guidance from the country."
Macro guidance is about what you'd expect from a nation that has methodically and with stunning success, pulled itself from centrally planned poverty to centrally planned prosperity (at least for some). But what does 'macro guidance' mean? GPS? RFID?
Today's Australian has all the intriguing details on China's Grand Strategy towards Australia in a story titled, "Beijing takes over BHP raid plans." The comments from the NDRC are a fascinating take on how at least some Chinese officials think capitalism works. "Globally, iron ore mines that are of high quality and easy to exploit are basically in the hands of major multinational companies. Our firms need to pay a high cost to mine iron ore resources abroad. Their exploitation risks and costs are increasing."
Is it really 'exploitation' to pay the market price for natural resources? Or is that just the language of socialism? Perhaps a crash course on free market economics is in order for the NDRC.
Not to sound too condescending (this coming from someone who uses the royal We), but you have to wonder if there is some wishful thinking going on in Beijing. Or maybe, after having lost money in Blackstone and Bear Stearns, state backed firms are wary of buying equity chunks in public companies. Maybe they want a different arrangement.
Either way, it is clear the Chinese have woken up to the fact that the century is theirs for the taking. But there seems to be some confusion about what rules the century is going to operate under: will it be mostly free market rules...or other rules. The market price for the resources China wants is rising. So it would prefer to not pay the market price.
By the way, we reckon free markets are headed for a bit of a bear market. Globalisation, in the bastard form we find it (where trade isn't really free and currencies are manipulated regularly) has produced US$114 oil, massive inflation, the worst credit crisis since 1929, food riots, and a growing popular backlash. Expect more direct government intervention and regulation in financial markets and, perhaps, resource markets. That should play right into China's hands, actually.
This latest line of probing rhetoric coming from China is not exactly a new line of attack. After all, the resources are there for the taking on the public markets. There's no need to attack at all. But it does feel like an attempt to flush out Australia's politicians and get them more involved in China's plans for Australian resources. The government is already involved, of course, with the Takeovers panel quashing the bid by Shougang Steel and APAC resources to take a 40% stake in iron ore up-and-comer Mt. Gibson (ASX:MGX).
Let's put this whole affair in the context of steel and GDP. We found the chart below yesterday while preparing for a radio interview with a Canadian business show. The host wanted to know how steel companies could afford to pay a 300% increase in coking coal prices and a 75% increase in iron ore prices. We asked him to picture the chart below.
Source: Mining and commodities exports, Angelia Grant,
John Hawkins and Lachlan Shaw, 2006
The chart shows that world steel production leapt ahead of GDP growth during the two big periods of Asian industrialisation of the last 50 years, in Japan and Korea. With China now industrialising, and coming off a much lower base in steel production, a period of growth in steel production that exceeded world GDP would be quite the spectacle. It would also mean China's consumption of base metals is just now hitting high gear.
From an Australian perspective, what's so flabbergasting about the chart is that both Korea and Japan have been devoted customers of the black coal from the Bowen Basin that is so well suited for coking. They've also been tied up for years as customers of Rio Tinto and BHP for the iron ore that comes from the Pilbara. Now you add China to the queue.
Despite its surge to the top in terms of global steel production, China's individual steel firms are still smaller, at least according to the latest figures from the International Iron and Steel Institute, than Japan and Korea. Nippon Steel, Posco, and JFE are all bigger producers than Baosteel. Keep in mind, however, that as recently as 2002, China was a net steel importer. It's now a net exporter.
Source: International Iron and Steel Institute
You could argue that Japanese and Korean steel production might decline as those economies age and become more service oriented. Yet major industries in both countries, including ship building and heavy equipment, are massive users of steel. And as of 2005, Japan ranked behind the EU as the world's second largest exporter of steel.
More likely than declining steel production by Japan and Korea is that they will compete for market share with Chinese producers. And the producers in all three countries don't seem to have batted an eyelash at higher input prices. That may be because they'll simply pass those higher prices right on customers. Steel prices are up by about 10% this year already.
But if you're wondering why steel producers don't seem panicked by rising coal and ore prices, there's probably a simpler explanation: there's a bull market in steel. When you combine the industrialisation going on in India and China with the massive commercial, residential, and industrial build-out in the Middle East (rebar prices are up 65% in the UAE this year), you get a pretty bullish case for steel producers. Consumption is rising at an enormous rate.
Australia ranks 22nd in terms of global steel production. Despite having an abundance of the two main inputs (coal and ore), the country, alas, has only 20 million people. Its demand for steel is low, which is why no single Aussie firm dominates the global steel-making stage. And so Asian steel producers have essentially outsourced their raw material requirements to the Pilbara, the Bowen Basin, and the Hunter Valley.
If you want to keep tabs on this three way competition for Aussie resources, watch the battle for infrastructure project at Geraldton. This projects brings rail and port access together to open up the lower-grade iron ores in the Mid West.
One project, put together by Yilgarn and Midwest (ASX:MIS), is embroiled in all sorts of intrigue. But with Sinosteel as the main JV partner of Midwest, this can be viewed as the Chinese project. The other proposal is backed by Murchison Metals (ASX:MMX) and Mitsubishi. It's the Japanese project. Korea is not represented, as far as we know.
To what lengths will Rio Tinto (LON: RIO) go to fend off the BHP takeover offer? Rio shares were up in London overnight by 6% on rumours that BHP would raise its share offer to 4-1 (currently 3.4 for 1) or ad some cash into the pot.
Rio and BHP keep quarreling over whose assets are better. With crude oil futures in New York cresting US$114, BHP is playing up its oil and gas assets. Rio managing director Tom Albanese is having none of it. He presented production figures from Rio's first quarter poured a cold latte all over BHP's oil story.
"I've seen numbers that would indicate to me that BHP Billiton's oil business is about 60th ranked in the world in terms of size...I would certainly rather be the leading player in the aluminium sector than the 60th ranked company in the oil and gas sector."
That's a nice quote. But it's a bit disingenuous isn't it? Size doesn't matter so much in terms of production. It's what you're getting for what you make. Just ask the coal producers on the East Coast. They're actually producing less coal for export this year due to infrastructure bottlenecks and flooding. But with higher contract prices, export earnings will go up on declining production volumes. That's not exactly how you'd draw it up. But you'd take it, wouldn't you?
Rio is even talking up its zircon assets in an effort to bolster its defences. The company revealed it found a big deposit of zircon-rich material in Victoria in East Gippsland. We laughed at this because we joked around the office yesterday about rising zircon prices. Mineral sands are intriguing, not least because James Packer and his lot have recently sold off their position in Iluka (ASX:ILU).
We are not so much interested in zircon as we are in rutile, titanium, tantalum, and lithium. We've been digging through the juniors in our research at the Australian Small Cap Investigator and have found the pickings slim, although there are a few plums there. Rio rightfully calls itself a world class explorer. But we doubt its zircon assets are going to fend off a persistent BHP.
The real bombshell from Rio's announcements yesterday is that it will sign a deal with Saudi Arabian Mining Company to build a giant aluminium complex in the Kingdom. The complex will include the whole aluminium chain, a power generation facility, an alumina refinery, and an aluminium smelter.
As we argued in a recent newsletter, aluminium is the most energy-intensive of the metals. Its production is migrating from cheap energy-challenged areas (China and South Africa) to energy-abundant areas (the Gulf States). The Saudi smelter will produce 617,000 tonnes of the metal each year, making it one of the world's largest. It will cost US$7.5 billion to build.
Rio didn't say how much it would get of that US$7.5 billion. But between Rio, Worley Parsons (ASX:WOR), Leighton (ASX:LEI), and a host of other Aussie mining services and infrastructure companies, the move by the Saudis into minerals and metals production should be good news for Aussie firms. Our preferred play on aluminium continues to be bauxite, the ore from which alumina is made, which later is smelted into metal.
The votes are running 20-1 in favour of more technical analysis. Ask, and ye shall receive, only it will probably be over at Money Morning. We want to make a home for Gabriel Andre's analysis of global indices, Aussie indices, and individual shares. But after careful thought, we believe that kind of approach is more suited to our sister e-letter, Money Morning.
The DR will stick with its skeptical end-of-the-worldism while Gabriel and Al Robinson over at Money Morning track money flows, moving averages, and the technicals (which are often described as the 'language of the market'. Watch this space for further details and feel free to write in with your suggestions to dr@dailyreckoning.com.au
How do you become a Decamillionaire? Easy! Move to Zimbabwe. Maybe it should be called a "Zimmillionaire." Reader Luke in WA recently came into possession of a paper currency note from Robert Mugabe's fiefdom. It had no watermarks and an expiration date. Luke placed it next to a gold coin to show DR readers the difference between real money and government fraud. Thanks Luke!
Dan Denning
The Daily Reckoning Australia
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Related Articles:
- America’s Next Great Commodity Boom
- RBA Leaves Rates Unchanged, Rio Wraps Up Negotiations
- The Saudi Arabia of Coal
- Every Investor in Commodities Should Know China is their Biggest Buyer
- Liquefied Natural Gas Goes Boom!
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by watcher7 on 17 April 2008:
With all the false-hype about China it is good to be reminded about another false-hype nearly twenty years ago.
Susan Walker, of Elliott Wave recalled:
“1989: Japan is in the midst of a multi-year boom in housing and economic growth, the Nikkei 225 has soared to never-before-seen nosebleed heights above the 30,000 level, and, in the ultimate display of East meets Western standards of wealth, Mitsubishi has just purchased New York’s Rockefeller Center.
“The land of the rising sun WAS the ultimate cover story: “Japan: From Superrich to Superpower” (Time) -- AND -- “Money Boom For Japan: Gilded Age Of Riches” (LA Times)
“In a matter of months, the Nikkei would enter a 14-year long bear market that slashed 80% off its value to a two-decade low. During this period, Japan’s housing bubble would burst, crashing land prices, public debt would soar to 140% of GDP, the economy would undergo its longest and deepest slump since World War II, and the flight of the soaring stock market would be replaced by the “plight of the suicidal salarymen.” (The Guardian)” (“Nikkei: In The Mood For Love?”, elliottwave.com, April 16, 2008).
The China Dream will eventually turn into the China Nightmare. The Chinese financial system will collapse and the economy will descend into anarchy and civil war leading most likely to balkanization.
Andy Xie, of Morgan Stanley observed that:
“In 751 AD China lost a battle at Talas against an Arab army. Historians view that as the turning point in the religious direction of the region. This event, however, was not so important in itself. China had vast resources at its disposal and could return to reverse the situation. What was important was that China deteriorated into chaos because of a rebellion by a key general and the ensuing wars so weakened the country that it could not influence the events in central Asia for centuries.
“As an aside, this historical episode illustrates the relative weakness of the Chinese system. China depends on power concentration for internal stability and, by extension, beyond. When the center is destabilized, everything else suffers.” (“China: The New Silk Road”, morganstanley.com, August 22, 2005).
Chinese saying “the hills are high and the emperor is far away”
The anarchy and civil wars in China, after the collapse of the monarchy in the early twentieth century, is a type for the challenges after the collapse of the Communist Party in the early twenty-first century.
Comment by Charles Norville on 17 April 2008:
Aren't we seeing a bigger boy on the block, China, taking the lollies off the US. Seems that the world needs China not the US and they certainly don't want the small incompetent Aus holding on to all that land and resource, not just whats in the ground but also the building area and agricultural land - has anybody realised that sovereignty is not an issue any more (its the economy stupid). Seems to me that the Aus and the world for that matter are being softened up for the Chinese to move into Australia (Kevin Rudd as Aus Leader is the start) - it makes economic for it to happen. The US spending on warfare is a joke, its becoming an international embarrassment for the US. Anyway China has its major trump in world recession revaluing up its currency 40%, who's going to complain if China buys up Aus, putting money into a stuffed economy. Just as well we have a Mandarin speaking leader.
Anyway China needs to act before nantechnology makes the cost of labour irrelevant.
Comment by Mike on 18 April 2008:
"We are not so much interested in zircon as we are in rutile, titanium, tantalum, and lithium. ..."
Please add tungsten, vanadium, manganese, molybdenum. Rises in prices of steel additives have matched the rise in iron ore and coal.
Tantalum is pretty much locked up by the private consortium that bought the Gwalia assets isn't it? (just forgotten the name of the company right now)
Comment by Diggin it! on 18 April 2008:
This nantechnology i know nothing of it! Can it build houses, roads, bridges or any other form of inforstucture? can it grow crops, retail goods, service tourism etc or is it for making stuff?
Comment by Coffee Addict on 18 April 2008:
Both China and Australia have major capacity constraints that will draw China's growth rates down from current level or 12%. Costs of production in China (at least along the East Coast) are rising for reasons that go way beyond the cost of iron ore and oil. On this trend, I expect China's economic growth to parrallel that of other countries in the region within about 10 years. India will I expect experience a similar outcome to China.
As Chinese production cost rises continue, expect cost effective steel production to occur closer to the source of the raw product and other igredients such as energy and water. Relative rises on transport and handling costs will push this trend in the same direction alonf the same trend line. In an nutshell, Australian steel production can be expected to increase over the next few decades. Baosteel will seek to own smelters in iron ore producing countries - with an emphasis on those with access to energy and political stability.
For better or worse, China is looking to Singapore for political, economic and social science benchmarks.