Chinese Metals Boosted by Stimulus

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Tony Daltorio, The Investment U Research Team

At least one government stimulus package seems to be working right now. But, it’s not the United States. If only our stimulus program was as successful as the “cash for clunkers.” Unfortunately, we’re closer to clunker with the rest of economic stimulus.

The stimulus package we’re talking about is in the country that many pundits love to hate – China. So far this year, China’s economy has accounted for virtually all of the world’s economic growth. Including China, global growth is 1.6 percent. Without it, growth was flat to slightly down.

Here are just a couple examples of China’s successful stimulus:

China’s auto market is now growing at 50% per year and has surpassed the United States as the world’s largest vehicle market.

China has already employed more than 100,000 people and spent $50 billion this year on high-speed rail lines. Over the next decade, China will spend $250 billion on high-speed rail. By 2020, they will have laid 16,000 of high-speed track. By comparison, the United States has only about 450 miles of high-speed track.

Such stimulus by the Chinese government has repercussions globally. For example, their infrastructure projects use a lot of steel. So repercussions are especially felt in the industrial and commodity sectors.

We’ll now take a look at one particular sector and at some of the metals that are important to steel making, particularly nickel and zinc and see if there are any profit opportunities for investors.

Chinese Steel Demand

As steel demand in developed countries has been extremely weak this year, China’s stimulus package has been critical for both the zinc and nickel markets.

Global steel production is a major factor in the demand for these two metals. In fact, 70 percent of all nickel is used for stainless steel production and 55 percent of all zinc is used for galvanized steel.

Global stainless steel output dropped by almost a third in the first four months of this year when compared with the same period last year. This production decline has even fueled speculation in the markets about consolidation in the industry, such as Posco and Arcelor Mittal merging their stainless steel production units.

In China, the government’s stimulus plan has fast-tracked many infrastructure projects, such as high-speed rail. The government stimulus plan helped Chinese steel production rise to over 600 million tons annualized in June, up 42 percent from the trough reached in October 2008 of 423 million tons.

As a result, capacity utilization at China’s steel mills has jumped to an average of 91 percent, compared with only 67 percent in October. If utilization rates remain high, Chinese steel prices could rise rapidly. This in turn could fuel further rises in the prices of nickel and zinc.

Metals Prices

Both nickel and zinc prices have recently charged to their highest levels of the year. The benchmark three-month prices on the London Metal Exchange for nickel recently rose to over $20,000 a ton with zinc reaching $1900 a ton. At the time, these metals were up 75 percent and 60 percent respectively.

In comparison, copper prices have doubled so far this year. Nickel and zinc are still lagging copper, but the rally for both metals has gained significant momentum in recent weeks.

One can almost hear the critics – “It’s just the speculators driving the prices up, not real demand.” To ease their mind, the critics should take a look at some of the ‘minor metals’ that are not traded on futures exchanges and are subject to little speculative investment.

Minor metals such as molybdenum, cobalt, antimony, ferro-chrome and ferro-molybdenum have enjoyed price gains this year. Ferro-chrome is up 25 percent from the year’s low; antimony is at an 8-month high, up 40 percent from the year’s low; cobalt is at a 9-month high, up 60 percent from the year’s low; and molybdenum is at a 10-month peak, up 85 per cent from the year’s low.

So much for blaming it on the speculators – the price increases aren’t because to them, but to rising Chinese demand instead.

Rising steel production in China has driven a huge increase in nickel imports, which reached 120,000 tons in the first half of 2009, more than double for the same period last year. Chinese imports may actually push the nickel market into a supply deficit for the remainder of the year.

This year’s revival in zinc prices is also largely due to China. Zinc imports in the first half of 2009 were 474,000 tons compared with 182,000 tons for the whole of 2008. Keep in mind that zinc that is considered to be one of the four commodities which are most leveraged to China, where China consumes about a quarter of global output annually. By the way, the other three commodities are: copper, soybeans and cotton.

Five Ways to Profit From China’s Hunger for Metals

There are several paths that investors can follow in order to gain direct exposure to the metals used by China in their infrastructure projects.

Investors can purchase shares in the large, high-quality global mining companies such as Vale (NYSE: VALE) or BHP Billiton (NYSE: BHP).

Investors can also purchase exchange-traded notes designed to track the performance of industrial metals. An examples is the iPath Dow Jones – UBS Industrial Metals Subindex (NYSE: JJM) which has nearly 30% allocated to zinc and nickel with the rest allocated to copper and Aluminum. Ipath also offers an ETN that is 100% allocated to nickel – the iPath Dow Jones – UBS Nickel Subindex (NYSE: JJN).

There are also exchange-traded funds designed to track the performance of industrial metals. An example is the InvescoPowerShares DB Base Metals Fund (NYSE: DBB) that has 1/3 each in zinc, copper and aluminum.

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Good investing,

Tony Daltorio