The Conversation (0)
Chinese economic growth will have a major impact on industrial metals in 2012. Columnist Amine Bouchentouf gives his recommendations on how to position your portfolio.
By Amine Bouchentouf − Exlusive to Resource Investing News
Columnist Amine Bouchentouf is a partner at Parador Capital LLC, an institutional advisory firm focused on commodities and emerging markets. He is the author of the bestselling Commodities For Dummies, published by Wiley. Amine is also the founder of Commodities Investors LLC, an advisory firm dedicated to providing insightful information on all things commodities.
While many casual market observers seem to know of China’s growing importance in the commodities markets, very few people have a solid understanding of what that actually means. Over the last five years, China’s growing importance in the global economy and commodities has been staggering and cannot be overstated.
China now accounts for over 40 percent of global copper consumption; 50 percent of global iron ore consumption; and 48 percent of global coal consumption. Even more important is that China’s consumption of key commodities is increasing year-over-year, both in relative and absolute terms.
China surpassed Japan to become the second-largest consumer of oil globally, right behind the United States. In fact, China has catapulted past economic powerhouses such as Germany, Japan and the UK to become the second largest economy in the world—and growing at a staggering 8-10 percent per annum. Therefore, one of the biggest market drivers influencing commodities in 2012—and particularly base metal commodities—will be the strength or weakness of Chinese economic growth.
Can we expect a Chinese hard landing?
Over the last couple of years, many market observers predicted a “hard landing” in the Chinese economy. Investors such as hedge fund manager Jim Chanos went so far as calling China “the big short.” However, China’s economy grew 9.6 percent in 2008, 9.2 percent in 2009 and 10.3 percent in 2010; even in 2011 it grew by a staggering 9.1 percent, proving many economists and investors wrong.
This growth is helping put a floor on commodities such as crude oil and iron ore. While we have seen prices for key industrial metals such as copper and aluminum decline in 2011, that decline would have been much steeper were it not for Chinese demand helping keep prices from succumbing to a total free fall.
At the same time, China is an export-driven economy and so is vulnerable to a global economic slowdown. Specifically, it is not immune to a European sovereign debt crisis which could have reverberations worldwide. Already we saw prices drop precipitously for base metals in 2011. Copper dropped 23 percent for the year, aluminum declined by 19 percent while other industrial metals such as lead, nickel and zinc were each down anywhere between 20 percent and 25 percent. Many of these price declines can be attributed directly to the fear of contagion from a European economic meltdown.
If Europe does implode, that will have a significant effect on China since the Eurozone is one of China’s biggest export markets. In such a scenario, China’s economy will cool down and that will decrease its appetite for commodities. On the flip side, if the European sovereign debt situation is contained you can expect China to remain strong which will be bullish for commodities in general and industrial metals in particular. Therefore, in the current macroeconomic environment China’s economic strength will depend to a large extent on the health of the global economy.
Industrial metals are the best indicators for global economic health due to their ability to measure global industrial consumption and production trends. Given 2011, what strategies should investors be considering in 2012?
What’s an investor to do?
The most prudent strategy at the moment is a monitoring strategy: closely monitor the economic data coming out of China, but also other key countries such as the United States and Europe. Equities still provide the most convenient exposure to industrial commodities, especially companies with exposure to both emerging market growth as well as OECD demand.
One company I recommend monitoring closely is VALE (NYSE:VALE), the Brazilian mining giant which is the world’s leading producer of iron ore, the key material for steel. VALE exports a large amount of iron to China, and is thus a good indicator of Chinese industrial activity. The company’s shares were down 35 percent in 2011, in line with the global demand slowdown for base metals. If there is a rebound in Chinese demand, expect VALE to be one of the main beneficiaries; this is a company I’ll be watching carefully, especially if Chinese economic data shows signs of strength.
In Latin America, Brazil is by far the leading supplier and producer of iron ore; however, another up-and-comer in the Latin American iron industry is Peru. Peru has a rich mining tradition and is a leading global producer of copper and lead. Recently, the country is also diversifying into iron ore production. This is a play I like because of Peru’s developed mining infrastructure which includes railways and advanced port infrastructure ready for export; what’s more, Peru’s geographic location gives it a natural edge over other Latin American competitors since it lies in the Pacific Ocean and faces directly the largest iron ore market: China.
One company that can offer you Peruvian iron exposure is Cuervo Resources (CNSX:FE,FWB:CRR). Cuervo has been operating in Peru for several years and has active prospecting and drilling activity on over 25,000 hectares in the country. The company has a resource estimate indicating 56 million tonnes of iron that’s measured and indicated. While still not in production, investors looking to get exposure to Peru should take a look at this stock.
In the copper space, I recommend keeping a close eye on Freeport-McMoRan (NYSE:FCX). Freeport is the world’s largest copper producer, and owns the largest copper mine in the world: Indonesia’s Grasberg mine in the Papua province. It does a lot of business with China and other key countries, so it’s a good company to track for a potential rebound in copper prices.
Another company in the copper space that I’m watching is CuOro Resources (TSXV:CUA), which gives you exposure to up-and-coming copper mines in Colombia. It’s well known that Chile is an important and mature player in Latin American copper markets, but Colombia is becoming an increasingly important producer in the region. This is a company that can give you that kind of exposure.
The bottom line is that 2012 will provide very interesting opportunities for the discerning investor. Monitor the data very carefully, and keep an eye out for momentum trades with a focus on key base metals such as iron ore and copper.
Securities Disclosure: I, Amine Bouchentouf, hold no direct interest in the companies mentioned in this article.