China demand doesn’t mean a one-way metals bet

The story of Chinese demand has propelled commodity prices for years now, and is a widely recognised driver of a ‘super-cycle’ in commodity prices.

But too often this leads to hasty assumptions that commodity prices will continue to outpace GDP growth in China, India and other big emerging markets.

“People invest in scarcity,” notes John Browning, head of metals at Newedge, a leading broker in base metals. “The supply of copper is finite. But then why do prices change? It’s because of investor expectations and flows in the markets.”

For example, he notes that copper prices have soared on the back of seemingly insatiable Chinese demand over the past decade. But Browning cautions that this does not mean copper prices are destined always to rise; in fact, lately they have suffered a retreat.

(Copper spot prices ranged between $4,000 and $4,500/pound from January until mid-August, at which point the price fell to $3,000/lb and are now trading around $3,500/lb.)

“Yes it’s the China story every time, but the Chinese hate high prices,” Browning says. “They’ll continue to build their infrastructure but they don’t have to buy copper tomorrow; their's is a long-term appetite.”

Although this may be true, other base metals experts – speaking last week at AsianInvestor/FinanceAsia’s commodities investment conference in Hong Kong – are more confident that Chinese demand means higher prices.

Peter Hickson, managing director and strategist at UBS, agrees that China wants lower prices. “But China sometimes gets it wrong,” he says. “Even they may be forced to come back to the market at times.”

Erik Bethel, Shanghai-based managing director at SinoLatin Capital, is also bullish on prices for certain commodities. He notes that China has become a major importer of copper because its own mines are depleted. Moreover, China is having to go to unstable places such as Afghanistan in order to bolster its supply.

Tom Findley, CEO of Rio Cristal Resources, an exploration company active in Peru, says Chinese companies such as aluminium player Chinalco are making huge, first-time investments into Latin America to gain control of mines, rather than rely on financial exposures.

This would appear to make it easy to predict that such deals are going to drive prices further upwards. But these transactions are not so simple or harmonious as they seem when they get announced. “The Chinese want a bargain and the Latin Americans want to charge high prices,” Bethel notes.

What’s the best way for investors to access base metals if they do buy the story of rising prices?

Browning prefers to ask what it is that investors actually buy. If they take an exposure to mining and exploration companies via stocks or an exchange-traded fund, are they punting on the commodities price, or buying into the people managing the company?

This is the dynamic that makes prices so volatile. “Futures or stocks can give you exposure, but expectations are constantly changing,” Browning notes.

For investors willing to stomach volatility, getting equity or futures exposure to junior mining companies is probably the purest financial play. Most of these are listed in Sydney or Toronto, as well as Hong Kong or London’s Aim market. Big miners or conglomerates with resources exposure – Rio Tinto, or GE – may be so big and diversified that their stocks correlate more generally with broad equity indices.

These stocks are high risk, and high reward. Investing in them requires old-fashioned skills of analysis. “Look at the management, their track record, their projects or asset base, and what geography they’re in,” says Findley.

Hickson advises investors to buy what China lacks, such as copper, and avoid what China has in surplus, such as nickel.

Findley and Bethel both suggest zinc could enjoy a good run. It’s been a laggard pricewise: five years ago it traded at $2,000/lb, and today hovers around $750/lb. But Chinese consumption is rising and now accounts for 45% of global demand; so far, China’s own production has met much of its needs, but its mines are becoming depleted.

“Zinc could be like copper was in the 1980s and 1990s,” says Findley. The question is whether China, which is the world’s biggest zinc producer, aggregates its small mines and creates more efficient production, or if it is required to turn more to overseas sources, such as Australia, Peru or the US.