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Australia’s Metal Miners hitch a Ride to China’s Economy

Gary Dorsch
Editor Global Money Trends magazine

Posted Jan 24, 2013

Navigating a metals mining company through the treacherous seas of the global economy is no easy task. There are many headwinds that can capsize a mining company or steer it far off course, if the captain of the ship doesn’t read the signals of the marketplace correctly. And it’s not only shareholders that can get hurt from calamitous decisions, but also CEO’s, such as Rio Tinto’s boss, who was sacked last week, because of a string of $34-billion of write downs, stemming from ill-timed and over priced acquisitions of aluminum and coal mines.

Miners must juggle many moving parts while trying to deliver new supplies of metals to the marketplace at a profit. The costs of mining are many, including those for energy, labor demands, decreasing grades of ore, stricter environmental regulations, and transporting natural resources to foreign buyers. That, along with increasing royalties paid to governments has the power to squeeze miners’ profit margins. In Australia, there’s a new 30% tax on iron ore and coal mine profits. In Indonesia, the government is telling miners that they must cede 50% of their ownership to the government. Peru is placing a new windfall tax on the resource sector that could raise about 3-billion soles ($1.1-billion) a year.

Recently, BHP Billiton scrapped a $20-billion plan to expand its Olympic Dam copper mine in South Australia and a new harbor, which would’ve doubled its iron ore exports in Western Australia. BHP blamed soaring development costs, a high Australian dollar and weaker metal prices for pulling the plug on the projects. Indeed, the selling prices of various commodities such as energy coal, iron ore, and copper, are not just set by the costs. Rather, they are set by the supply and demand of the marketplace, including the fickle nature of speculators, who buy and sell metals for quick profits, and can obscure the true level of industrial demand. Over-production causes prices to fall, sometimes below the cost of production. Heightened demand causes higher prices and eventual shortages.

Following the two-year recovery in base metal prices in 2009-10, the world’s top-40 mining companies invested $98-billion in capital projects in 2011. They drew-up plans for a further $140-billion for 2012 in an effort to increase supply. But the unexpected plunge in base metal prices in the summer of 2011 caused many miners to nix those spending plans, against a backdrop of shareholder demands for heightened capital discipline. CEO’s of mining companies became even more cautious on capital spending, as the market price of the iShares S&P/TSX Global Mining Index Fund (Toronto ticker: CMW) lost more than a third of its value from the peak level at the start of 2011, before finding support at CD$16 /share.

The iShares Global Mining Index, traded in Toronto, has since stabilized from its nasty fall, and rebounded towards CD$18.50 per share, amid signs that China, - the world’s biggest buyer of base metals, sucking-up 40% of global supply, is experiencing an upturn in its economy, led by a rebound in its exports and industrial sector. Of all the variables that the CEO’s of mining companies must gauge, perhaps the most important is the outlook for China’s economy. That’s especially true for the big-3 miners of iron ore, - the key ingredient for making steel. In 2012, China produced 716-million tons of crude steel, or 46% of the world’s output. By 2015, Beijing aims to bring 60% of world’s output of steel under the control of its top 10 steel mills, while increasing its reliance on imports of iron ore from Australia’s miners.

China’s Economy – key Driver for Australia’s Miners

China’s economy grew at its slowest pace in 13-years in 2012. However, a year-end growth spurt, spearheaded by Beijing’s decision to spend 1-trillion yuan ($157-billion) on various infrastructure projects, lifted industrial output. Together with a surprising jump in exports, China ended Q’4 with a growth rate of +7.9-percent. Although the slowest since 1999, China’s economy was comfortably ahead of Beijing’s growth target of +7.5%, which just months ago seemed to be in jeopardy. Moreover, traders are optimistic that Beijing has the necessary tools and the know-how, to steer its economy away from a “hard landing” and can navigate the world’s #2 economy towards a healthy +8.5% growth rate in the year ahead.

If correct, Australia’s streak of exceedingly good fortune would extend for a 22nd year. Not since 1991, has Australia suffered through a recession, - defined as two straight quarters of economic contraction. Because of its recent “coupling” to the juggernaut Chinese economy, it’s been the only major industrialized country that was able to avoid the fallout from the “Great Recession” of 2008 that still haunts Europe to this very day, and badly wounded the US-economy. Today, Australia’s $1.37-trillion economy is ranked as the world’s 13th largest, despite being ranked 52nd in terms of population.

It used to be said that when the US-economy caught a cold, the rest of the world caught pneumonia. However, this is no longer the case. While it’s still the world’s biggest economy, the US-economy is not very important any longer for Australia. Instead, Australia’s fortunes have become increasingly linked to China’s. The view that Australia’s economy might actually have become “coupled” with China’s began to gain credibility in 2001. It was in that year that the Australian economy avoided the same fate as Europe, Japan, and the US, which fell into mild recessions, while Australia’s managed to squeak out a growth rate of +0.70-percent.

This was noteworthy because on the previous two occasions the US-economy had gone into recession, in the early 1980’s and the mild contraction after the Iraqi war in 1991, Australia’s economy was quick to follow. Empirical research has found that during the 18-year period ranging between Q’1 of 1983, and Q’1 of 2001, the correlation between the cyclical behavior of Australia’s economy and the US’s business cycle was extremely high at 82-percent. Since the turn of the century however, Australia’s economy became increasingly linked to China’s, and less in tune with cyclical swings in Japan and the Western world.

That became most apparent during the depths of the “Great Recession,” especially after the top-52 equity markets had lost a combined $ 30-trillion in market value from their peak levels in October 2007. The economies of Europe, Japan, and the US simultaneously plunged into severe downturns, yet Australia’s economy managed to escape the fallout, with just a minor scratch, - a single quarterly GDP loss of -0.7% in Q’4 of 2008. Yet even that loss in economic output was quickly recouped with a +0.8% gain in the subsequent Q’1 of 2009.

Even while unemployment in the 17 countries that make up the Euro zone rose ratcheted-up to 11.8% in November, with the number of jobless workers hitting 18.8 million, and caused Germany’s economy to shrink by -0.50% in the fourth quarter of 2012, Australia’s economy didn’t skip a beat, expanding by an annualized +3.1%. Europe only buys 4% of Australia’s exports directly while China alone takes 26% of Australia’s exports. “I remain confident that Australia, with its strong government finances, resilient banking system, relatively low exposures to the troubled Euro-zone countries and strong links to the dynamic Asian region, is well placed to deal with events that may unfold,” said RBA deputy Governor Ric Battellino.

China’s $7.4-trillion economy was rocked by the severe fallout from the “Great Recession” in Europe, Japan, and the US. China’s economic growth rate has been quite volatile, ranging from as high as +14.8% to as low as +6.6% over the past dozen years, - growth rates that make politicians in recession ridden Europe and Japan quite envious. For the past 20-years, China’s economy has averaged +10% growth per year, roughly 3-times as fast as Australia’s has grown at an average annual rate of +3.6% for over 15-years. Highlighting the linkage between the two economies, the RBA has been emphasizing the growth rate of China’s economy, rather than its own economy, when setting its overnight cash lending rate.

China has also become the key driver for world commodity prices. In only 30-years, China would become the #1 consumer of copper, steel and iron ore in the world - consuming more them than Japan and the US combined, as well as the #2 user of crude oil and energy, agricultural goods and other non food commodities, such as rubber and cotton. This in turn had huge impacts on commodity rich countries, such as Australia, Brazil, Russia, Canada, Middle Eastern oil rich countries and South Africa.

Mining exports, especially to China, have propelled the growth, and now account for 20% of Australian GDP. Investments in mines and related infrastructure account for 8-percent. The country also has resource projects worth A$425 billion under way or planned as miners try to meet demand from the urbanizing masses of China and India. Therefore, investors in Australian mining companies, such as BHP Billiton (BHP.N) and Rio Tinto (RIO.N), must be able to juggle several moving parts at any given moment in time. Key variables such as China’s volatile economic growth rate, the value of the US-dollar versus key currencies, central banks’ monetary policies, and an awareness of the break-even points for global miners, are just a few of the hot potatoes that investors must learn to juggle correctly.

To read the rest of this article, please click on the hyperlink locate below:

http://www.sirchartsalot.com/article.php?id=172

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Gary Dorsch
SirChartsAlot
email: editor@sirchartsalot.com
website: www.sirchartsalot.com


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Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group. As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADRs and Exchange Traded Funds.

He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.

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