Hot commodities

The truth about rare earths and other matters…

Hot commodities

Expert views: Dr Fan Gang and Clinton Dines

Earlier this week, WiC attended HSBC’s inaugural Global Commodities in Asia Conference at the Marina Bay Sands in Singapore. The conference focused on four main themes: metals and mining, energy, agriculture, and shipping and ports and brought together leading companies from Asia, Europe, North America and Latin America.

China was prominent, with attendance from industry leaders including China Coal, Baosteel, Jiangxi Copper and Yanzhou Coal. Guest speakers also included Chip Goodyear, Sunny Verghese and James Grant.

China was also discussed directly on the second morning in Singapore, at a panel discussion involving Dr Fan Gang, Director of the National Institute of Economic Research, until recently a member of the Monetary Policy Committee at the Peoples Bank of China, and Clinton Dines, former president of BHP Billiton China, who first arrived in China in 1979, and is now chairman of Caledonia Investments Asia.

The questions were posed by Garry Evans, HSBC’s Global Head of Equity Strategy.

Let’s start with your views on the direction of the Chinese economy…

Fan: In the short run, it’s looking pretty stable. Six months ago there were worries about overheating but those fears are basically gone. Then we had the debt problems in Europe, and concerns that the Chinese economy might be slowing too much. But the recent data shows growth is still strong, so the government is more relaxed about the risks of a slowdown. In fact, it’s more focused on inflation, hence the recent rate hike. But I think we’ll be OK for a two-year horizon and inflation won’t hit the levels of 2007/8. Instead, expect inflation in the 3-4% range. Investment will also continue, especially from corporates. Real estate investment needs to come down, although the crackdown on the property bubble is only really in leading cities, so projects will continue to grow elsewhere.

So overall: boring times ahead!

Boring can be good sometimes… What about the RMB: will its current value stoke up asset bubbles and trade tensions?

Fan: The current situation is manageable on asset bubbles, especially with a gradual revaluation. Revaluation will happen. Think about the 2005 to 2008 period, when we had a 22% revaluation. China’s businesses coped with that. It wasn’t too great a shock. And trade frictions are normal. We’re used to them, especially during US elections! But one possibility I can see ahead is export controls on US high tech goods.

And the shift to a consumption led economy?

Dines: Everyone’s telling the Chinese to spend more and save less but they’re shifting as quickly as they can. Retail sales are a good proxy: they have been up 15%-plus year-on-year for at least the last 5 years.

Of course, it’s true that the contribution of consumption to Chinese growth has fallen over the last 20 years. But that was because China was underinvested – they had to put more money into capital stock, so proportionately consumption becomes less. But China is a continental economy that will need more capital stock for another two decades. We have to keep that in mind and not just nag them about saving less and spending more. We saved less and spent more – and look where it got us.

Will the political transition ahead also mean major policy change?

Fan: No, it shouldn’t bring any surprises. The whole process is now very institutionalised. But you can say that the next generation of leadership has more grass-roots experience of the market economy. They were the governors and mayors during the opening up years, and they have had more direct contact with foreign companies too. That will make some difference.

Just don’t expect major reforms: it’s going to be continuation rather than dramatic change.

We’re at a commodities conference, and China’s voracious demand is a key theme. But resource prices must hit a ceiling?

Fan: I believe so, yes. Commodity prices are still running up as demand moves higher, and the pressure will be there in the long run. But people will work out a way to find more resources. China is working on efficiency too, with a major programme on energy savings, as well as moves to reduce market distortions like price subsidies.

Dines: Price growth is going to moderate, as you’re growing off a much higher base. It’s still a story of demand growth for the next decade; but you’ll get a supply response, so prices need not necessarily go up forever.

You need to look carefully at the impact of price rises too. In 2004/5 we were pilloried mercilessly at BHP when we announced a 71.5% increase in the iron ore price. That represented about $20 a tonne extra in the cost of steel. Then the steel producers gleefully put up their prices by $200 a tonne and pointed the finger at us as price gougers!

You need to look at some of the current rare earths story in the same way. Take lanthanum, which journalists have been talking about as going up 350% in the last 3 years. That makes it about 4 cents a gram now. If you work out how much lanthanum there really is in your mobile phone, it’s about 20 cents worth. Do you feel a lot of inflationary pain as a result of that?

Something similar applies to the debate on the price of iron ore or copper – you’ve got to isolate the impact of commodity price rises on core price inflation. Does it really cause demand destruction? For example: buy a car in the US, and the steel, copper or aluminium in your average model is going to be about 5% of the cost price. Compare that to the 25% going towards US autoworker pensions!

But doesn’t China feel vulnerable, especially in iron ore where there are only three producers?

Dines: It did get very emotive, and the miners have to take some blame on how they handled the public narrative. But I think China didn’t understand the impact that it would have in sucking up supply and making it into a sellers market. Then the government started worrying, and their approach became too anxiety-driven.

Fan: We have the ‘going out’ process just beginning now and it’s true that China is a new participant and needs more experience. But the Chinese are also worried about the long-term increase in demand for natural resources, the challenges in securing long-term supply, and that prices will continue to rise.

Dines: There has been some strategic immaturity. Back in the 1960s and 1970s, the Japanese went overseas and took a little bit of seed equity in new projects. The goal was to ensure that new supply got built; then they secured long-term contracts on the resources that resulted.

But, as I said, Chinese buyers have been a bit too anxious, and perhaps not as analytical. Plus their model is that they want to buy and own, not like the Japanese who preferred to induce suppliers to build more capacity in order to get prices down.

That will happen in future too: iron ore is the classic example on a five-year horizon. Demand will go up but so will supply, so prices will be hit. There’s going to be blood on the floor for some of the people opening up high-cost production now.

Iron ore was a hold out on benchmark contracts, but we’ll look back and wonder why we fought so hard over it, especially as benchmark pricing is now basically broken as we move into shorter and shorter contract periods. Rio has more or less said that it is starting to price on a monthly basis.

Think how the benchmark was set up: fixing a single price for a year, which doesn’t change even as supply and demand moves over that period. The only guarantee was that either the buyers or the sellers were going to end up annoyed by year-end.

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