Is China Attempting to Lower Commodity Prices with a Buying Strike?

We had some large developments in the commodities market yesterday with the biggest news being that China has agreed to accept Rio Tinto's (RTP) iron ore contract prices of a 33% cut rather than the 40% to 50% China was looking for.

Surely this is another "loss of face" for China; in fact, you almost feel it is now red in the face from being slapped down again.

Yesterday we read how China is kicking its "own goals" on its play on aluminum, and how its plan to support the industry has led to a massive stockpile, and how China is now dumping aluminum back on the market and lowering revenue for the companies it was trying to save.

Now five dramatic and alarming factors have emerged overnight in regards to China and particularly the link with the Australian mining sector. Notably, it now appears that China will attempt to lower commodity prices by going on a buying strike, although this is not a clear cut argument or fact.

The following are excerpts from a story by Robert Gottliebsen here.

First, according to the Fairfax China correspondent John Garnaut four members of the Rio Tinto sales team have been detained in Shanghai since Saturday and there have been raids on the Rio Tinto China offices. Those detained and probably arrested include an Australian citizen, Stern Hu. This development shows that the loss of face went far beyond Chinalco and extended deep into the Chinese administration.

Second, I may be wrong, but I link this outrageous extension of Rio Tinto toughness to the challenge China is facing in one of its key resources provinces, Xinjiang. We are seeing a different side of China and we in Australia are going to need all the talents of Kevin Rudd to steer us through this – we should avoid aggravating the situation with politically correct remarks.

Third, Chinalco has reaffirmed the need for the Chinese mineral industry to make strategic acquisitions overseas in a drive to secure supplies. Chinalco’s Xiao Yaqing says: "The crisis presents a rare opportunity for our domestic companies to initiate cooperation with foreign enterprises. When the time is ripe, overseas acquisitions, strategic investments and joint development could all be considered."

That’s the Chinese way of saying "get out there and do it

Fourth, as part of those Chinalco remarks I understand the Chinese are setting up at least one large fund to buy into struggling junior explorers around the world in an attempt to break what they see as the Rio Tinto-BHP ring around them. The Chinese think long term.

Fifth, there is further evidence that the Chinese are preparing to use their stockpiles of metals to lower prices to make it easier to buy into mineral companies. UBS analysts led by Peter Hickson say that China may cut refined copper imports to around 100,000 tonnes a month in the July to December period – around two thirds of the average of 280,000 tonnes a month in the first five months.

According to a Mining Journal report, UBS claims there are "clear indications that China is now overstocked". The Strategic Reserve Bureau is offering up to 100,000 tonnes of copper to the market and traders are preparing for exports of the metal.

UBS estimates that China may have stockpiled 500,000 to 700,000 tonnes of copper in excess of its industrial needs in the first quarter – only 300,000 tonnes of which "is apparently destined for the Strategic Reserve Bureau".

However the Mining Journal quotes a different view from Yang Gang, a trader at LG International Corp, who says Chinese imports "couldn’t decrease sharply in the second half". Many long-term contracts have been booked and importing copper as a way to obtain finance is very active, he says.

Our five dramatic developments show that we have entered uncharted space.

All of these points show that China has a massive influence on commodity prices going forward and the individual share prices of mining companies around the world. As investors, you would do well to understand whether China is sniffing around or investing in mining shares you may or may not hold.

Disclosure: I currently do not own Rio Tinto or BHP shares.

Comments

[Ben Gee:]

Rio used Chinalco to get a better deal. Was that a smart move? We will see in the coming months. If China could forced commodity prices up by over buying, I guess China can do the opposit. It appear that China has enough in store for a few months. Can Rio live a few months with low commodity prices? Was it smart to make a fool of your best customer?

Jul 10 05:04 AM

[Maxe Paul:]

Although Chinalco was the saviour for Rio at the time, the March doomsday period, the deal was very one sided in Chinalcos favor. In the end it was deemed by shareholders that a capital raising would be fairer for all concerned.

Chinalco could have offered a better deal but they played high stakes poker IMO, and lost the key hand, though do not forget they took up their shares in the capital raising at a substantial discount to the Rio share price.

I do not believe Rio made a fool of Chinalco, but rather Chinalco "lost face" which is in many respects in China one and the same. In Australia we see it as a "that's business" moment.


On Jul 10 05:04 AM Ben Gee wrote:

> Rio used Chinalco to get a better deal. Was that a smart move? We
> will see in the coming months. If China could forced commodity prices
> up by over buying, I guess China can do the opposit. It appear that
> China has enough in store for a few months. Can Rio live a few months
> with low commodity prices? Was it smart to make a fool of your best
> customer?

Jul 10 09:51 AM