China’s Raw Materials Markets Send Prices Soaring. Why?

Monday, August 10, 2009 2:22
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A lot of discussion surrounding the recent metals/ materials pricing volatility, and China’s role in driving that volatility.

Many of the recent reports I have seen seem to indicate that the purchases (and imports) of raw materials are a good sign, a sign that China’s factories are turning the light back on as a result of increased orders. Other reports take an entirely different approach by pointing to stockpiling of materials, stockpiles that will take years to work off and should be viewed as a sign of inefficiency.

It was a topic that we myself and several others discussed last week as part of our What if beers, and after come further thought, and through this post I wanted to offer up some different theories.

Before I do that though, I thought it best to frame the issue a bit with some other unrelated discussions I have been having, discussions that I believe show the manufacturing economy is not the driver. The first discussion was with a member of the risk consultancy community last week, a person whose business has seen the number of factory closures increase over the last year and says are still ongoing. The size and breadth of the closures was still fairly unknown to them as their clients were those who were not locking the doors and skipping town, but were large enough to be negotiating upfront, and it was clear that the numbers and the firms involved were not insignificant.

The second conversations were not really a conversation, but and emailed response to a question I sent to two friends of mine inside large global logistics firms… “howz business” . The first response… “DEAD”. The second response… “Inventory replenishment orders not occurring as hoped for… bad”. That was all I needed to know that despite the recent upturn in Shanghai’s port figures, that the logistics industry was clearly not seeing an increase in containers, and that (as I have written about before) was an indication that the manufacturing economy was not back on.

So, what is causing the surge in metals and materials? Why are Chinese firms importing these goods when the demand for their processes/ finished goods has not returned?

Here are a few of my theories:
1) Speculation – First, quite clearly there are a number of groups who see this as a chance to speculate. Many of the commodities that were at all time highs last year have seen their markets fall out from underneath them, and that leads some to believe that investing in these assets will bring returns… once the economy pops back.

2) Counter inflationary investments – The inflationary issues that China faced during 2007-2008 with inflation, were issues that nearly brought parts of the country to a standstill. Oil was in short supply, coal was unable to make it to producers, metals prices were reaching the stratosphere… and China’s competitive postion as low cost leader was being questioned. IT was a condition that lead to the central government putting up the money and infrastructure for a strategic oil reserve, but it was the bottoming out of oil that lead the reserves to be filled up 9 months early. That, in short, with so much cash on its hands, counter inflationary stock piles can be built so that if there is a run up in prices the stock of cheap supplies can be used.

A tactic that only China could pull off right now, and a tactic that could give Chinese firms a significant advantage going forward as the industrial machine overheats again.

3) They have nothing else to do with the money – During the recent round of beers one of the participants said that as part of the government stimulus “Banks have a responsibility to loan money, and firms have a responsibility to spend it”. the problem was, as we all agreed, that we were not seeing the money spent in the ways that one would hope for. That the massive expansions in operations and investments have not been occurring, but leaving the money inside a savings account is going to do no one any good either. The traditional asset markets (real estate and equity) have already seen a huge run up in the last 12 months, and so these goods are seen as a way to park their cash for a while and perhaps make some money.

For me, while the first theory is the one that the Chinese government is most concerned with (due to its tie to hot money), it is #2 that I find most interesting as the implications could be significant in the context of global manufacturing.. and it is this one that I will keep my eye on as it will potentially have the greatest impact on the real economy.

If anyone else out there has other theories, feel free to post them in the comments section.

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