Miners are blind to China's new reality

Commodities regained some ground overnight but in the long term China's rising minerals demand is not sustainable. If our mining costs stay high our markets will be heading for a fall.

Last night we saw copper and other commodities recover ground because markets believe we are going to see another round of stimulation.

And it is possible the markets will be right but it’s important to understand some of the deeper forces behind the recent declines which have sparked the big fall in mining shares despite this week’s recovery.

A KGB interview with Patrick Chovanec, to be published on Monday, helps explain why Australian mining shares have fallen so far.

Right now Chovanec is the chief global strategist of Silvercrest Asset Management but he has just completed a five-year-term as a professor at the Tsinghua University’s School of Economics in Beijing.

Chovanec believes the situation in China is more serious than is generally understood in Australia. And it is certainly a lot more serious than the position painted by our Prime Minister Julia Gillard at the ADC China Summit and in her KGB interview. In essence Chovanec says that the great growth rate in China’s demand for minerals that Australia has seen in the last four years is simply not going to be sustained.  

At best we will hold steady but demand could easily fall quite a lot. China invested vast sums via its official and secondary banking systems in infrastructure and other projects which have proved to be uneconomic.

Most of the projects were funded with borrowed money and now we are seeing interest rates of eight to twelve per cent in Chinese short term securities as the capital markets scramble to fund these exercises. A big portion get that the growth in China’s credit is required to simply fund the extra costs involved in the interest rate burdens of this enormous expenditure. And to the extent that credit is being created for new projects, those projects are simply not delivering the sort of growth that we have seen in the past.

At the same time exports to the US are struggling in some areas because of the rise in American manufacturing and China is also seeing increased automation – both events are causing labour retrenchments. All this adds up to a correction in China. A minor correction would be very healthy but it could become more serious if the Chinese encounter difficulties in managing it.

Alternatively, they may attempt to do what the Japanese did and hide the problem under the carpet in which case at some point of time it will explode into a very nasty recession.

All the above forces compound into the fall in commodity markets and our mining shares. Unfortunately Australian miners have become among of the highest cost of the world and unless there is a breakthrough in our cost structures we are going to cut off most of the new projects that have not been started.

For what it is worth I believe that banning of cartel-style agreements in building and mining areas is the first step in reducing our costs. But pain involved in regaining that competitiveness will be high and unfortunately the first step in that process is the fall in mining shares – which forces companies to look hard at their costs. 

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