Erik Bethel's  Instablog

Over a three day period last week, the country of Bolivia hosted a forum focused on natural resources. While Bolivia has a strong resource base with ample reserves of silver, tin and natural gas, many of the participants of the forum came to learn more about the world’s hottest new commodity: lithium. Bolivia sits on 5.4 million tons of the element (used in making lithium-ion batteries), approximately 50% of the world’s reserves.

At that forum, Bolivian President Evo Morales made some clear statements about his vision of the lithium industry. Specifically, he warned that lithium will not become a “new chapter” in his country’s “history of pillage and poverty.” And Morales admonished future foreign investors to become “partners—not owners—of the lithium industry.”

“If we don’t take measures,” he added, “we will never change Bolivia. We will continue down the path of pillage. We cannot repeat another Cerro Rico de Potosi (Bolivian silver mine that was recently shut down), neither in lithium, nor iron ore, nor oil.”

Evo Morales nationalized the entire Bolivian oil and gas industry and most of the mining industry since he assumed power in 2006. And his government recently ordered the partial suspension of the mining activities in Cerro Rico, a mine currently owned by Coeur d’Alene, but which has been operating for almost five centuries.

Bolivia’s lithium reserves, purported to be the largest in the world, are located in an enormous salt flat known as “El Salar de Uyuni.” At the natural resource forum, Morales declared that he believes that Bolivia will produce 30,000 tons of lithium carbonate annually starting in 2013 (the global demand today is 70,000 tons, much of it being supplied by neighboring Chile). He further declared that the lithium industry will be 100% state-owned and that will cost US$350MM to build the lithium carbonate plant. At a future stage, Bolivia plans to develop a battery plant and perhaps, in conjunction with foreign firms, battery-powered automobiles, but this will require an investment of US$1 billion. Insofar as how foreign firms could participate in the lithium industry, Morales assured the participants that there would be “clear laws” regarding investments and returns, but he did not offer a time table on when they would be announced. And he was clear that the Bolivian state would own the lithium industry, while foreign companies need to accept the role of “partners not owners.”

It is increasingly clear that lithium will have a valuable role in the “green revolution” sweeping the world. One interesting, albeit expensive, way for investors to play lithium is SQM, a US$9 billion Chilean firm that trades on the NYSE. SQM is mainly a fertilizer company (potassium nitrate, sodium nitrate, etc), but it also has a robust lithium carbonate business. It seems that investors have “re-discovered” SQM, as the company’s stock rose from $18 to $40 per share this year. While it's a good lithium play, it may be a bit expensive. The stock is trading at a FV/EBITDA of 16x.

Chinese firms definitely pulled out their checkbooks this quarter.

According to a report published by the Ministry of Commerce (MOFCOM), Chinese companies invested US$20.5 billion overseas in the 3rd quarter for a year-on-year increase of 190%. Who are the buyers? Mainly state-owned companies (SOE's). What did they buy? Almost exclusively natural resources in over 100 countries. Over 40% of the transactions involved acquiring a controlling stake. These statistics exclude financial sector acquisitions and off-take deals (such as China's US$10 billion arrangement with Brazil's Petrobras).

Here (below) is a chart showing China's share of world commodity usage.

China imported 405 million tons of iron ore so far this year, an increase of 30% from 2008. Much of this iron ore came from Brazil—specifically from Brazil’s gargantuan iron miner Vale SA. Vale has ridden the commodity-to-China wave and has made a tremendous amount of money in the process. Its year-to-date stock price is up 120% (compared to the S&P roughly 20% rise) and its market capitalization today is roughly US$140 billion.

Things may soon change, however. Brazilian legislators are considering the implementation of a new royalty payment system in the mining sector. This royalty could increase fees that mining companies like Vale pay to the Brazilian government, especially those that simply export ore and do not “add value in Brazil.”

Miguel Nery, Head of Brazil’s National Production of Mineral Production (DNPM), stated that the plans are in motion to send the new royalty laws to Brazil’s Congress, along with other, wide-ranging changes to Brazilian mining laws.  “It hasn’t been decided yet, but the royalty rate will likely be higher for mining companies that do not add value to the raw material in Brazil,” said Nery, who argued that he does not believe that the laws will in any way slow down new investments in the mining sector. Brazilian mining companies, meanwhile, chafe that new royalty payments will make certain new projects less financially viable.

Vale, the world’s largest iron ore mining company, has been especially singled out. The pressure could force Vale to take larger stakes in Brazil’s steel companies. Last week, Vale’s CEO met with Brazil's President Luiz Inacio Lula da Silva following strong government criticism that the company was not doing enough to advance the country's steel industry. Lula insists that Vale should not simply export raw materials but should also develop higher value-added products. To its credit, Vale has made minority investments in the Brazilian steel industry. But the company insists it wants remain a minority shareholder in most of its projects in order to avoid competing with its clients.

Last week, the Wall Street Journal Asia reported that (of all things) a Hong Kong-listed "lighting-equipment manufacturer" Bright International Group, will purchase 8 Chinese gold mines. The deals are valued at US$956.1 million. You might ask yourself why this is happening. In our opinion this is a combination of raw opportunism and dollar devaluation fears.

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Given the financial crisis, it looks like China's investments overseas in 2009 will eclipse those of foreign investments into China for the first time in history. According to Peoples' Daily, this year China could invest 150 billion U.S. dollars overseas. This is three times more than last year's figure of US$52 billion.


Source: ODCE, Ministry of Commerce, China Statistics Bureau, Tralac report (2007), World Trade Atlas (2008), MOFCOM

People's Daily also states that, China's role in the global economy will shift from "manufacturer" to "capital exporter." Fan Chunyong, standing director of China Industrial Overseas Development and Planning Association explained that, "30 years of economic development has enabled China to accumulate a large amount of capital. Chinese capital will naturally flow overseas if that market has lower cost and higher profit than domestic investment." China's net investment position for 2008 is detailed below. What will 2009 and 2010 look like? We see China's dollar denominated Fx reserves shrinking in percentage terms while outbound FDI increasing.


Source: State Administration of Foreign Exchange 国家外汇管理局（SAFE),亚洲经济数据库（CEIC）

So far this week Chinese metals companies are propelling the stock market further. The Shanghai Composite Index closed at 3,060, having risen close to 60% this year. Stock market leaders include China’s 2^nd largest metals producer Jiangxi Copper, which gained 4.3% on Tuesday, and Aluminum Corp of China (Chinalco) which rose 4.5%. Steel giant, Baoshan Iron and Steel (Baosteel), was up 0.5%, while Shougang Steel was up 2.0%. The sentiment in China is that China seems to be recovering and metals producers will continue to rise along with construction and infrastructure spending. There are other factors at play as well. Namely, the fear that if the US recovers, it will increase the velocity of money. In simple terms, the money that has been parked in U.S. banks will actually start circulating. And more money chasing few goods is inflationary. In China many investors feel that putting money in mining stocks is an inflation hedge of sorts.

 

In other notes, Macquarie came out this week with a report China may suffer a “shortage of iron ore” given that Chinese steel companies have not been able to sign long-term contracts with global iron ore companies. "Because the Chinese refused to sign a formal contract,” noted a spokesperson for Macquarie, “the iron-ore producers are pulling tonnage out of China and pushing it back into Japan, Korea, Taiwan and Europe.”

 

And finally, last week China’s Ministry of Industry and Information Technology (MIIT) announced that it would put together “guidelines” for consolidating China’s steel industry by the end of 2009. This is big news, actually. There are hundreds of inefficient steel companies in China and Beijing wants them to consolidate. The general premise is that larger, more powerful firms will have the leverage necessary to deal with the Big Three iron ore companies (BHP, Rio Tinto and Vale), and larger firms will (in theory) be more environmentally conscious and socially responsible. Stay tuned on this one. The big winners could be Baosteel and Angang Steel.