THE BEIJING AXIS China Business in Perfect Strokes

The last quarter of 2008 saw the end of a general boom in the global mining industry. While some commodity analysts could foresee the collapse of mining and metal prices, very few could predict or react to the rapidity and harshness of the fall. Record prices, net profits and expansion plans in the first half of the year suddenly gave way to a fall in commodity prices, reduced profits, production cuts and mine closures in the last quarter of the year and the first half of 2009.

With stronger balance sheets and an overwhelming confidence in the key supply and demand drivers of the industry, Chinese mining companies are not only finding new opportunities in the current predicament, but are also set to emerge from the crisis with an enhanced role in the global mining industry.

Different impact, different responses

With the unfolding of the financial crisis and the dramatic decline in demand, commodity prices entered a freefall. This severely affected investors’ confidence, who rapidly started selling their shares, resulting in a severe drop of the market value of listed mining companies (both small-cap companies and blue chippers). According to Mine, the PwC annual report on the global mining industry, in 2008 the market capitalisation of the world’s top 40 mining companies had dropped by no less than 62% below 2006 levels.

With stock prices down and limited means to generate internal cash flow from actual operations, the only source of funds left open is equity financing. But with the credit crunch, the ability of firms to raise funds in the market has been virtually impossible, resulting in reduction of explorations, divestments, difficulties in debt repayments and increasing risk of being taken over or bankruptcy. Yet this was not the case with Chinese companies.

In addition to the backup provided by record profits achieved by Chinese mining firms in 2007 and 2008, Chinese banks and financial institutions, which had minimal exposure to subprime assets, were encouraged by the government to support their domestic champions. As a result, China’s state banks had lent nearly USD 1.1 trillion in the first half of 2009 (more than the USD 800 bn US stimulus package), while Peoples Bank of China announced that China's forex reserves had reached USD 2.13 trillion, the first time any country had surpassed the USD trillion benchmark.

As expected, Chinese firms have not been slow to make the most of the opportunity.

Hunting for bargains

With the market value of the world's mining and metal companies low at present, Chinese mining firms are eager to pursue overseas acquisitions at attractive prices. Yet from the other side of the chessboard, Chinese companies are perceived as the only fund-raising strategy available to survive the commodity cycle. For Chinese mining firms, the timing is just right.

A good example of this is CMN, a subsidiary of China Minmetals, which recently acquired the Australian miner OZ Minerals, the world’s second-largest producer of zinc. OZ Minerals urgently needed cash to refinance its debt, and CMN finally raised its bid to USD 1.38 bn. In another move to reduce bank debt, Canada’s largest diversified mining company, Teck Resources Ltd, recently sold a 17% stake to China Investment Corporation (CIC), China’s USD 200 bn sovereign wealth fund, for USD 1.74 bn - the first major Chinese investment in a Canadian company. And the list goes on.

The stockpiling fever

The Chinese are not only finding opportunities in investment but also in trade. With the collapse of commodity prices in mid-2008, and considering the ample availability of credit provided by domestic banks, China started to import massive amounts of metals and minerals, setting new import records.

For example, China's iron ore imports in June hit 55.32 million tonnes, up 46.6% y-o-y (also up 29.3% for the first six months y-o-y), reaching the second highest level on record after April, while refined copper imports climbed to 378,943 tonnes, up 398% y-o-y (also up 159% for the first six moths y-o-y). It was a similar story with nickel, all contributing to China’s build-up of strategic stockpiles, which has enabled China to kill two birds with one stone.

Firstly, China needs resources to feed its growing economy (with GDP growing at 7.9% in the second quarter of 2009), and with current prices it seems to be right moment to buy. This is largely thanks to China’s fiscal stimulus package of USD 585 bn, much of which will be spent on infrastructure and the construction of highways, roads and bridges. China’s manufacturing is also expanding as the stimulus is being implemented. Secondly, the Chinese government is actively supporting the domestic mining industry. When China’s State Reserve Bureau (SRB) announced in December 2008 that it would fund the acquisition of a large metal stockpile, it had to push domestic prices up again, at least high enough for local producers (miners and smelters) to get back to their production lines.

Yet this has also had some collateral effects. As spot prices have increased, some traders, speculators and domestic producers with import licenses made use of the easy lending to buy cheap ores abroad and stockpile these in the ports, waiting for metal prices to rise again.

Aware of the unsustainability and associated risks of strategic stockpiling, representatives of China’s National Development and Reform Commission (NDRC) recently announced that the government had stopped its metal stockpiling programme. This may potentially push down metal prices again overt the short term and let actual projects in infrastructure balance the fall.

High expectations or actual recovery?

Industry experts believe that the long term fundamentals of the industry will sooner or later push metals and mineral prices up again. Yet the questions right now are when and how fast this will happen.

While the future prospects of the industry still remain uncertain and will strongly depend on a substantive rebound of the demand in US, Europe and Japan, China’s resource need will remain high in the long term and its outward investment footprint in the metals and mineral industry will likewise deepen. International companies able to anticipate China’s expansive trends and able to position themselves strategically will create significant advantage for their shareholders.