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Not all Chinese Cash Boosts Commodities

June 3, 2010

“It is rarely a good idea to become overly reliant on one customer. Especially when that customer is trying to build a rival supply business of its own. China accounts for 36% or more of global demand for metals like copper, aluminum and zinc, according to Barclays Capital…

One big risk with a key customer is that its appetite wanes. Another, less obvious one, when it comes to China is its effect on the supply side.

China’s approach to dealing with its shortages of raw materials is ‘to throw money at it,’ says Jennifer Richmond at Stratfor, a global intelligence firm. Chinese firms have spent $79.6 billion acquiring foreign natural-resources producers since the start of 2008, according to Dealogic. Meanwhile, Beijing has struck deals from Russia to Africa offering loans and infrastructure development in exchange for minerals.”

Source: The Wall Street Journal, June 2 2010

Observations:

  • Using various investment funds, banks and state-controlled companies, China has invested in building production capacity across the world. Not only in Africa, but also in Australia and Asia the Chinese are building a supply foothold.
  • WSJ’s Denning argues that the increase of production capacity caused by the Chinese investments will eventually lead to overcapacity and thus to decreasing commodity prices.

Implications:

  • The potential oversupply created by Chinese investments is certainly a long term issue. Most investments in the mining industry do not lead to output in a period shorter than 5 years. Many things can happen to the demand in that period.
  • Apart from the need to build capacity to satisfy the demand increase, the surge in investments in exotic places is driven by the decreasing ore quality of the average new mine. Companies need to mine lower grade ores in more extreme places. As the investment required per ton of output increases, the investments will not necessarily increase supply at the same levels as demand. As long as China grows at 10% per year, it is going to be very hard to keep up in terms of production.

©2010 – thebusinessofmining.com

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