Hello EP, Andy may be a bit too early on this one, but at times it is good to be early than late:
Asia Pacific: Hard-Rock Dotcom
Andy Xie (Hong Kong)
morganstanley.com
It is starting to feel like 1999 in China÷Õ mining industry.?But the stars of the show are older and wear hard hats this time around rather than the black turtlenecks favored by dotcom entrepreneurs.?I ran into an ex-IT gal the other day who was planning to list several steel mills in China.? Her dotcom adventure didn÷Ö make it to market before the crash, so I wish her luck this time.?Recently, when I was in New York a friend excitedly whispered to me that his cousin had won the right to invest in an iron ore mine in Hebei.?A senior executive from a major mining company showed up in my office a few months ago, his face glowing as he spoke of China÷Õ tremendous need for mineral resources.
Make no mistake, these rocks are hot.?Nickel prices are up 71% year-to-date, lead by 54%, and copper and tin by 32%.?These humble metals have easily beaten gold÷Õ performance, which has frustrated many speculators.?I am often asked: ø‡on÷Ö Chinese want to keep some of their wealth in gold?? When I reply that Chinese don÷Ö like gold anymore, people are usually shocked.?It is true that in the past I have written about the potential demand for gold toilet bowls in China but times have changed and these days China÷Õ fashionable youth prefer platinum÷Õ color far more.
Whenever I was asked how to take advantage of China÷Õ growth, my answer was always to buy some global resource companies, as I thought that its industrialization would have a greater impact on resource demand than the reconstruction of Europe and Japan after World War II.?I still believe this to be the case.?But cycles still matter and China is like a growth cyclical stock.?The secular trend is up.?But cycles can be quite violent and investors should not extrapolate the current peak cycle trend into the future.
Of course, one can never be absolutely sure about when the peak will be.?Thus, as long as the cycle continues, the commodity prices could still rise.?Many called the top of the IT bubble in the 1990s and only watched the Nasdaq continue to surge.?Could I be making the same mistake here??I don÷Ö think so.?China÷Õ investment demand, which is the primary driver for its commodity demand, is all funded by credit.?When the Chinese Government decides to slow down, the demand for commodities will weaken.
Hence, calling the demand slowdown depends on what the government does.?I believe that easy credit in China has been cut off.?The only uncertainty is how long the lag is
Exhibit 1
Metal Price Changes in 2003 (%)
Aluminium??????????12.7??????????Zinc?????????????? 23.5
Gold???????????????15.6 ????????? Copper????????????32.1
Silver??????????????14.5 ????????? Nickel?????????????71.5
Platinum??????????? 28.1 ????????? Lead????????????? 54.0
Palladium??????????-20.3??????????Tin???????????????32.3
Source: CEIC
between credit and demand.?I think it is about one quarter and that commodity prices will soften sharply in 1Q04.
China has a tendency to frontload investment or raise leverage via rapid credit growth that borrows from future GDP growth.?What has happened since the start of 2002 fits this pattern.?China has created Rmb4 trillion of credit (40% of 2001 GDP or 33% of estimated 2003 GDP) above trend in the past seven quarters.?Wisely, the government has cut off easy credit to prevent a financial collapse.
Credit growth this time has raised leverage in government finance.?Local governments have become dependent on revenue from selling land and other income related to the property sector.?As property developers borrow from banks to pay the governments, a significant chunk of the credit growth has become government revenues, which in turn has funded urban infrastructure projects.
There is nothing wrong with local governments mobilizing resources through the land market for urban development.?I have advocated this model before (see The Third Growth Anchor, June 28, 2001).?But, when the land market is taking off, it has a big one-time impact on GDP growth.?Normal growth resumes when the base effect kicks in.
China÷Õ cycle also has an impact on supply.?For intermediate commodities, the massive capacity formation in China now will have a dramatic impact on their prices.?China is likely to have more capacity for the production of aluminum and steel than it needs in 2005, in my view.?Many other commodities are likely to be in the same shape.
The impact for minerals could also be quite negative.?As mineral prices have risen, marginal capacities are being brought to the market funded by speculative capital.?When China÷Õ credit cycle comes off, somehow every industry faces excess capacity.?I doubt that this time will be any different.?China÷Õ long-term story is bullish for natural resources.?But watch the cycles.
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