04/06/2013 - 14:03

Opportunities in China’s stop-start strategy

04/06/2013 - 14:03


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Opportunities in China’s stop-start strategy

CHINA slashed its demand for iron ore exactly a year ago, triggering a collapse in the share prices of Australian mining companies.

History appears to be repeating, but this time investors have a chance to profit from the cuts rather than incur heavy losses.

The difference is that some actions taken by China are predictable, partly because beneath its capitalist veneer it remains a command economy – and companies do what the government orders.

Last year's industry-wide cutback in imports of iron ore and coal was an example of how China can react to pressure in its economy as if it were a single, giant, organisation, which in some ways it is.

Australian investors have little experience of a situation where a country simply stops buying some of our exports in one month, only to resume a few months later.

China, however, has a track record of actions like that.

And this year could be a repeat of what happened last year, and what happened in 2008, with the difference being that smart investors will have learned the way the game works and be ready to profit from the process.

Rather than watch and wait for the next episode in China's game of turning off its raw materials purchasing machine (and then turning it back on), it is possible to pre-empt what's about to happen because of certain reasonable assumptions, such as the critical importance to China of maintaining a strong economic growth rate to ward off domestic instability.

Last year, when the purchasing switch was flicked to 'off', the price of iron ore plunged to less than $US90 a tonne, catching companies such as Fortescue Metals Group in the middle of an expansion phase and dangerously exposed to high debt levels.

Investors panicked. FMG's share price crashed to less than $3 and an emergency funding package was organised.

Within a few months the crisis passed.

Chinese steel mills returned to the market (as if ordered by a central authority) and FMG's share price moved back above $5.

The reason it's worth looking back to what happened is that the process appears to be under way again, with the headlines on stories about China's raw material demand almost interchangeable from last year to this year.

On May 20 last year, London's Financial Times newspaper carried a story headed 'China buyers defer raw material cargoes'.

By August 10 the Chinese absence from the market led to this headline 'Iron ore and coking coal prices tumble', and by September 4 the news was 'Fortescue slashes expansion plans'.

It isn't pleasant to look back at what was a difficult time, but it is significant that the trail of falling prices and cancelled orders ended on September 11 when it was reported that 'Iron ore up on China stimulus plan' followed on September 18 with news that FMG had secured a fresh $US4.5 billion debt facility. The crisis had passed.

There is no guarantee that what happened last year will be an exact replica, but there is interesting evidence pointing that way, including the sharp fall in the iron ore price over the past three weeks, which led to this headline in the Financial Times: 'Iron ore suffers sharp fall on fears of outlook for China', which was followed by FMG's share price falling back towards the $3 mark.

This year's headline is interchangeable with that of last year, with the only difference being an 11-day gap between the May 20 report last year and the May 31 report this year.

Making money from what looks to be a predictable Chinese process of turning its raw materials purchases on and off is a question of timing; and while there is no guarantee that the current price collapse will be over by mid-September, as it was last year, there is every reason to believe that Chinese buyers will return to the market – because they must.


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