Ecclestone on where the Chinese blew it.
Is the recent turmoil in Chinese markets (with its subsequent contagion to the Western markets) the last gasp of the commodities Supercycle? The Supercycle is somewhat akin to a sailor getting swept off a yacht at sea. As long as a body is not found floating, some of his friends will continue to believe (at least for a while) that he has somehow survived and is out there hanging on to a piece of flotsam or sunning himself on a tropical island waiting to make a big comeback when rescued.
Those who entertained doubts that the Supercycle was off on some R&R now have to face the fact that the dearly beloved is now gone to a better place and that life shall have to go on without it.
It is simplistic though to say that the Supercycle was just China. It could not have been such a force of nature unless some other factors had come into play. Chief amongst these was underinvestment from the 1980s onwards in base and specialty metals production. To this consideration must be added the effect that Greenspan pump-priming had after the Tech Bubble Implosion of 2000 and then the attempts to avert a trauma-induced recession in the wake of the September 11 events of 2001. Both of the latter events triggered a liquidity expansion that made the gold and silver price take off. If the Supercycle was just Chinese economic expansion sucking in base metals then there would not have been a corresponding rise in precious metals, which really had nothing to do with the Chinese economic surge. They were merely coincidental.
The Supercycle was built on the back of not just Chinese demand for metals imports but ALSO because the Chinese had themselves reached a point where they had squandered enough of their own metals (e.g. zinc) through a beggar-thy-neighbour policy through the 1980s and 1990s that had plunged prices to levels uneconomic for many Western miners to maintain their mines in production. During the lean years of the 1980s and 1990s countries like Chile maintained production of copper because Codelco was a massive State enterprise while many Southern and Central African production zones had extraordinary low wages for workers. South Africa in the dying days of apartheid needed to keep foreign earnings rolling in and underinvested in mines and paid low salaries to compete against Chinese “dumping” of base metals. In some senses the South African energy crisis of today is due to underinvestment dating back to that period.
Therefore Chinese predatory pricing in the preceding decades generated, in the first years of the new century, the shortage in base metal production from Western mines shutting down and miners underinvesting for such an extended period. In effect the Chinese ruined the market for their own metals and then ended up having to “pay up” for imported metals as the price for having done so.
Where the Chinese Blew It
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The Chinese had a rather unique opportunity to achieve a type of dominance over global metals that the British achieved in the late 19th century in the wake of the Industrial Revolution and massive imperial expansion. And yet this did not happen. Where did the Chinese go wrong?
- They did not establish a global champion in trading (all the trading houses, with the exception of Noble are Western based)
- They bought a number of copper mines (e.g. Peru & Mexico) when they could still get away with it and never developed them
- They failed to develop mining companies at a global scale to compete with the likes of BHP and RTZ. MMG is the best they could manage
- They failed to develop specialty markets for the commodities in which they had pole position. The FANYA Exchange was worse than a joke, it was a cesspool
- The Shanghai Metals Exchange got off to a good start and has credibility on price but continued scandals relating to warehouse statistics mean stockpile numbers are always suspect
- Lending to Chinese traders against stocks is fraught due to repeated scandals related to collateral (linking back to the warehouse numbers)
- Smuggling of specialty metals is endemic both into and out of China making trade/production figures severely suspect and distorting markets
- Condoning and even encouraging clandestine and illegal mining (e.g. Antimony in Burma)
- Treating African countries like colonies importing contractors from China to undertake all construction work and then creating cantonments of Chinese gastarbeiter guarded by “security firms” that are really seconded from the PLA
- Suborning African leaders and administrations
- Essentially expelling all foreign mining companies from operating in China
- Rubbery, opaque and deceptive accounting at listed Chinese miners
- Cavalier attitudes to corporate governance at listed Western miners where they have taken control or have a dominant stake
- Squandered scarce resources in metals where they had a dominant position in the mistaken belief that this dominance could last forever (e.g. Antimony and the ionic clay deposits containing REEs)
- Condoned and even encouraged highly polluting mining practices within China that have created environmental disaster zones that may never be remediated due to their significant extent
- Ramped and then dumped the REE market to “show who’s boss” in the process shooting themselves in the foot, by encouraging large Western producers of Lanthanum and Cerium to enter production, thus damaging China’s own viability at bulk light REE mines like Bayan Obo.
- The metals sector is still largely state-controlled and has been subject to regular periods of management paralysis as Beijing power cliques rotate in and out of power. This is interspersed with purges of the corrupt and inefficient OR the non-corrupt and efficient.
And that is just in the mining and metals industry…
The “Masters of the Universe” stance the Chinese took in recent years was starting to get a bit old and events in recent weeks have left the Chinese economic wonder looking like a chicken that has been well and truly plucked. The attitude that the Chinese economy was omnipotent and infallible has been dealt a severe blow. Not only has there been a strong retreat in expectations but serious weaknesses have been exposed. The stock market in China has been shown to be little more than a casino inhabited largely by investors who are neophytes with little knowledge or interest in what they were investing. This has always been a recipe for tears. In the 1920s in New York it was said that when the bellboy starts asking you for market tips then get the hell out. China has very much been like this of late and is now paying the price.
Stripping back the veil of infallibility has also exposed a broader economy that was dependent upon constant pump-priming. This reality was already evident to the mining community that had perceived in recent years a decided slowing in purchases by the Chinese, a probable stasis in stockpile accumulation and selected dumping of some metals into the global market (e.g. REE & Antimony). Beyond that we had the smoke & mirrors of the warehouse/collateral scandals and the FANYA Exchange being exposed as an Emperor without any clothes. Global dominance must be made of sterner stuff.
The China-driven Supercycle is dead, long live the Supercycle! Metals will be dependent henceforth upon more measured Chinese demand and a revival in Western demand. Also prices are more likely to be driven by supply shortages caused by long-term underinvestment rather than by soaring net consumption. The latter is no longer a feature. A whole swathe of metals (but not iron ore) have seen prolonged underinvestment since BEFORE the crash of 2008 and that will be the motor for a much longer and better sustained supercycle combining a scenario of scarce funds for projects, higher capex and opex for every pound produced and grade erosion after a long period of high-grading at many legacy mines. If you perceive our tone as bullish then you perceive correctly..
Christopher Ecclestone is a Principal and mining strategist at Hallgarten & Company in London. Prior to founding Hallgarten & Company in New York in 2003 ... <Read more about Christopher Ecclestone>