On August 3rd, Rio Tinto, the world’s second-largest miner, reported a 75% first-half profit surge to a record $3.8 billion, driven by higher copper and iron ore prices. Sales rose 23% to $10.6 billion, with a third of its exports going to Japan (20%) and China (14%) in the first-half. Copper and iron ore accounted for 78% of Rio’s profit, with higher metal prices boosting earnings by $1.8 billion, more than offsetting higher production costs of $513 million.
RTP’s share price had doubled in anticipation of stellar earnings, and was also coveted after it won a tender to privatize the Peruvian La Granja copper project which has two billion tons of copper ore. But RTP’s shares doubled to $247.50 per share on May 10th, 2006, and in hindsight, reached a climactic peak, before plunging to as low as $185 per share by June 13th, in sympathy with a worldwide stock market meltdown, and a 20% setback in the London base metal Index.
RTP regained its footing in the summer of 2006, settling into a sideways trading range of $195 to $215 per share, and closely tracked the price of copper. Following the dog days of summer however, traders began to unload copper futures from as high as $3.70 per pound towards $3.35 /lb, which in turn, knocked RTP shares from stiff horizontal resistance at $215 /shares towards $185 /share.
Then, in an unusual divergence, RTP extended its losses towards $176 /share on Sept 25th, although the price of copper has stayed buoyant at $3.44 per pound. On a short term basis, RTP appears to be oversold relative to the price of copper, and due for a quick speculative bounce. However, underlying RTP’s longer term weakness, are linked to fears of a synchronized slowdown in the Chinese and US economies, the world’s two largest copper consumers, in the months ahead.
The chart pattern for BHP Billiton, the world’s largest miner, looks almost identical to the RTP graph. BHP is the majority owner of the world’s top producing Escondida copper mine in Chile, and owner of the massive Olympic Dam mine in South Australia, which holds the world’s largest uranium deposit. BHP was a market darling until May 11th, when it topped out near $50 per share.
After consolidating in a tight sideways trading range of $41 to $44 per share for the summer of 2006, BHP suddenly plunged after September 4th, to as low as $34.75 on Sept 25th. BHP began its descent, after reporting a 77% jump in second-half profit on strong metal prices of $6.1 billion, which swept its full-year profit 63% higher to a record $10.45 billion. A highly confident BHP had announced spending plans for as much as $14.4 billion to expand and build new mines and oil fields.
The latest meltdown in BHP shares since Sept 4th coincided with stern warnings from Chinese policymakers of a tighter monetary policy, designed to slow its juggernaut economy. Also, prices of existing US homes were 1.7% lower in August 2006 from a year earlier, the first drop in 11 years,. That could make it tougher for US consumers to tap home equity to keep up spending. Cash-out financing from US homes exceeded after tax income gains by $175 billion in 2005.
China’s economy grew 11.3% in the second quarter, the fastest pace in more than a decade. But “booming spending on factories may create overcapacity, driving prices and corporate profits lower and ultimately leading to more bad loans at China’s banks”, the World Bank said in April. That could cause an abrupt slowdown in the world’s fourth-largest economy, the lender said. China is the biggest consumer of steel and copper and the second-largest of crude oil.
On Sept 10th, PBoC chief Zhou Xiaochuan indicated that China’s growth was “a little bit too high, and there are several macro-economic adjustments to slow it down a bit. Liquidity is still abundant in the Chinese economy so we are going to squeeze the liquidity. There are several ways, we can either expand the operations on open markets, or we could once again use reserve requirements, it’s flexible,” he warned.
“China’s priority for the rest of the year is to rein in capital spending and it will rely more on monetary policy measures, rather than administrative curbs, to do so,” warned Vice Premier Zeng Peiyan on Sept 10th. “The priority for the second half is to control the over-rapid increase in fixed-asset investment. We will try to rely less on administrative measures and mainly use economic and legal measures in our macro controls,” Zeng declared.
“That includes appropriately adjusting money supply and credit and taking comprehensive measures to mop up liquidity in the banking system. We will also improve the formation mechanism of the yuan’s exchange rate.” Two days later, the PBoC backed up its tough talk with action by mopping up a record 225 billion yuan ($28.3 billion) in its open market operations on Sept 12th. That was nearly double the 120 yuan withdrawn from banks by the PBoC on July 12th.
In the event that the PBoC tries to engineer a 7-8% growth rate, as the latest downturn in Australian mining shares suggest, then tremors would ripple through-out Asia. A sharp slowdown in the US economy, linked to a downturn in the housing market, is another big risk to China’s economy, where exports amounted to 40% of its GDP, compared with about 25% in France and 10% for Japan. Chinese exports soared to $90.77 billion in August, up 32.8% from a year earlier.
In August, Chinese imports jumped to a record $72 billion, a stunning 24.6% higher from a year earlier. Therefore, any sharp slowdown in the Chinese economy would rattle neighboring exporters in Australia, Japan, and South Korea, whose sales to China are at all-time record highs. Already, Korean exports to China, which grew in excess of 50% during 2004 and into 2005, have slowed to a pace of 12% in the first half of 2006. China accounts for more than 20% of Korea’s foreign sales.
Japanese exports to China expanded 26.1% to a record 4.9 trillion yen in the first half of 2006, but are at risk from a synchronized slowdown in the China and the US economy, its two largest customers. Australia is the world’s largest shipper of coal, uranium, and iron ore, and commodities account for 60% of its exports. Total exports to China surged 39% to A$10 billion from a year ago. Japan is Australia’s largest customer, whose economy is at risk from a Chinese and US slowdown.
On Sept 18th, Qiu Xiaohua, commissioner of the Chinese National Bureau of Statistics, said Beijing should aim to achieve annual economic growth of between 7% and 8% to keep output on a sustainable path. “Judging from constraints upon capital and energy supplies, an average annual GDP growth rate of 7-8% is manageable, but a growth rate of 9% is not,” he concluded.
“Growth of 9% would create massive oil supply shortages and lead to such rapid expansion in investment that it would warp the economic structure and make it difficult to sustain growth. Annual growth of anything beyond 9% would probably lead to an inflation rate of greater than 5%,” Xiaohua said.
Southern Copper, the world’s third largest copper miner, owns the Toquepala and Cuajone pits in Peru and the Cananea mine in Mexico, as well as La Caridad. PCU has the world’s second largest reserves of copper, behind Chile’s Codelco, but its share price is showing signs of fatigue, after a spectacular surge until May 11th. PCU pays a hefty dividend of 9%, but traders are wary about copper’s stamina, due to worries of a Chinese slowdown and a deflating US housing bubble.
Copper is 16% below its record high of $4.15 per pound set record in mid-May. Copper stockpiles at the London Metals Exchange have increased 350 tons to 121,625 tons today, but represents less than three days of global consumption. Despite the tight supply situation, large speculators at the NY Comex increased their net-short positions by 18% to 11,042 copper contracts in the week ended Sept. 19th. That could set the stage for a short squeeze in copper prices due to tight supplies.
The average US home requires about 400 pounds of copper, and conditions in the US home building sector have deteriorated significantly. On Sept 21st, KB Home said a challenging home building market was not likely to improve in the foreseeable future, and its net orders of 5,989 homes were down 43% from a year ago. In the existing market, the supply of homes for sale increased to 3.92 million, a 7.5 months supply, its highest since April 1993, up from 7.3 months at the end of July.
Yet despite the horrific news on the US housing market, home builder shares are showing signs of stability after a 50% correction, anticipating the Federal Reserve could begin lowering the fed funds rate by as much as 75 basis points to 4.50% in early 2007. Also, it remains uncertain whether Chinese policymakers will actually carry out their threats of a tighter monetary policy. Thus, looking forward, metal mining shares such as BHP, RTP, and PCU should remain highly volatile, due to shifting outlooks for Chinese and Federal Reserve monetary policies.