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Keep an eye on the Lao Security Exchange, which per reports hopes to raise $8bn in stock and bond sales in order to generate investment into the country over the next five years. The market opened last week and lists only two companies (Electricite du Laos Generation or EDL, a unit of the state-owned power producer which overseas investors are limited to a cumulative 10 percent stake, and Banque Pour Le Commerce Exterieur Lao or BCEL, the state controlled lender whose shares are verboten to foreigners), but as Templeton’s Mark Mobius noted, the admittedly woefully underdeveloped communist country and subsistence-farming oriented economy still offers “valuable opportunities” in industries from construction to banking as it increases its infrastructure investments. For one thing, future consumption will be underpinned by the purchasing power parity (PPP) rise of a population of roughly 7 million people, 40 percent of whom are under 15 years old and currently earn only $2.6 per day on average (as an example of how explosive this kind of low-base growth can be, consider Vietnam, where GDP based on PPP/per capita trebled since 1995 after rising roughly 5x since 1980). For another, the country has several heavy and hungry hitters with skin in the game–Beijing is covering 70 percent of the project investment for a high-speed railway link (to this end, watch if and when domestic Lao cement producers ever list shares or raise debt, since domestic cement is cheaper to produce but will be dear for years to come), for instance, while also building up resort, hotel and casinos along border areas for its growing base of tourists and also joint venturing in order to secure access to raw materials such as iron ore. Thailand, another source of tourism, will also purchase 95 percent of the electricty generated by the country’s initial $1.3bn hydroelectric and World Bank supported-dam, one of many dams which could ultimately allow Laos to become “Asia’s battery”. To this extent, “Laos is fast establishing itself as one of the principal territories in the South-East Asian region for large scale and innovative hydropower project financings,” according to Allen & Overy’s Ben Thompson. Finally, watch for a potential secular rise in mineral/metal prices (copper, gold and silver specifically) and its related dealmaking to support Laos’ future economic development.
A good proxy on not only the continued and perhaps also subsidized demand across the globe for green, low-carbon technology, but also the desire among increasingly rich (in terms of income per capita), developing countries in particular for more ‘sophisticated’ products such as flat screen monitors, Ipods, and laptop and cell phone batteries, is the price of rare earth elements (REE). The startling rise in the index (see graph, right), which covers ten of the seventeen metals in question, is a function of Chinese export reductions (China controls 97% of global REE production but has limited its quotas by 40% YTD) and more pointedly, per The Economist, its desire to “drive its manufacturers from low-to high-value goods.” The immediate effect on market prices is understandle given just how essential REEs truly are to a bevy of industries. Per the EU Times, for instance, “global demand has tripled from 40,000 tonnes to 120,000 tonnes over the past 10 years, during which time China has steadily cut annual exports from 48,500 tonnes to 31,310 tonnes. Worldwide, the industries reliant on REEs, which produce anything from fibre-optic cables to missile guidance systems, are estimated to be worth £3 trillion, or 5 percent of global GDP.”
Yet as any Econ 101 student could predict, this relatively sudden price rise (coupled with the obvious national security and other geopolitical implications) is quickly giving way to an almost equally rapid supply response, though admittedly there will be a time lag in exploration and production that could send prices even higher in the near-term before the inevitable snapback. Molycorp (NYSE: MCP), an American firm that IPOed in late July (its shares are up over 20% since listing) and mines a previously unprofitable (due to the cost of correcting environmental concerns) mine in California that was once the largest source of REE in the world, will “start production by the end of the year and go full-scale by 2012,” per the MHFT and shares of Western Australia’s Lynas Corp. (LYSCF) have also risen as a Chinese-sponsored takeover was thwarted by the government (though please keep buying our iron ore, officials surely suggested). Meanwhile, Japanese firms such as Toyota and Sumitomo have already opportunistically snatched up mines in exclusive deals in Vietnam and Kazakhstan, respectively. Expect further mines across the frontier to go at premium prices. If indeed we are in midst of a resurgence of the commodity super cycle, then rare earth elements will be one of the most heavily sought. To what degree and how quickly suppliers meet this demand, however, will determine what path the index takes in the near term.
Further confirmation of the gradual manufacturing shift away from China and towards regional frontier markets in an Economist piece this week (“Culture Shock”) about how the rising number of labor disputes in China (largely revolving around wage increases) is beginning to intensify the country’s “shift from being the world’s workshop to its shopping mall: as employees demand and get higher incomes, the country’s attractiveness as a manufacturing base ebbs but its appeal as a consumer market grows.” While companies’ collective response has to some degree been in part to mollify the wage demands, “firms with labor-intensive work have been shifting it to cheaper Asian countries like Vietnam, Thailand and Cambodia. Uniqlo, a clothier, plans to reduce its proportion of Chinese-made garments from 90% to 65% in the next three to five years.” Of course, foward-looking investors are already contemplating the next logical step. Per Paul Collier, a professor of economics at Oxford, “over the past three decades, offshoring shifted labor-intensive manufacturing from the OECD countries to Asia. In the next decade, expect the same process to begin shifting these activities from Asia to Africa.”
In a speech given to mining investors while in Johannesburg earlier this year, Frontier Advisory CEO Dr. Martyn Davies reiterated the case for frontier, and specifically, Africa-centric investment:
“If you believe in the long-term urbanization success story of China and India, you buy Africa, because that’s where the commodities are going to come from,” Davies told the audience.
Endowed with 30% of the world’s minerals, the African continent is experiencing continued attention and capital from Chinese and Indian firms which, according to McKinsey’s sub-Saharan Africa principal Dr. Heinz Pley, will concurrently provide growth to those economies as well as those in Africa itself:
“The Chinese have a long way to go to reach the personal income levels that Europeans and Japanese had. There is a lot of room left for growth in China and there is India in the wings and actually also Africa, in the long-term, will create significant demand for commodities, and no longer merely produce commodities for the rest of the world,” Pley said.
While global mining projects had been hit just as hard as global banks, Pley remarked, the turnaround–predicated presumptively on domestic stimulus and a lending surge–has been even more dramatic. Yet some observers note that China’s commodity appetite has far exceeded the mere arbitraging of raw material spot and futures prices and instead gone into the risky realm of inflated, speculative inventory building. Back in June, Macro Man, a London-based manager, penned an interesting post on what he called “The China Syndrome” that infers whatever Chinese buyers are now giving to the commodity cycle, they will ultimately take away in terms of rate of change:
“While overall [Chinese] imports have barely started to recover in value terms, many commodity imports have absolutely skyrocketed in volume terms. And at the end of the day, the inputs to China’s industrial and investment complex are based on volume, not value,” he wrote.
For reference, China’s coal and iron ore imports by volume through 2008 are shown below:
PT Adaro Energy, Indonesia’s no. 2 coal miner (behind PT Bumi Resources Tbk, which by contrast will send 8 million tons to China this year), stated recently that it had already contracted much of its increase sales to China of 3.5 million tons in 2009–up from roughly 2 million tons last year–while reiterating that Chinese demand for overseas thermal coal would remain “robust”. China imported over 11.5 million tons of Indonesian coal last year–more than a quarter of its total. Australian coal prices on the globalCOAL Newcastle index, a benchmark for Asia, ended Friday at $74.31/ton, while port coal prices at China’s top coal port Qinhuangdao remain around $92 a ton. “As long as there is a difference between domestic and import prices, China will still be buying coal from overseas,” commented Apimuk Taifayongvichit, chief marketing and logistics planner at PT Indo Tambangraya Megah, the Indonesian unit of Thai Banpu, which noted this week that it is looking to acquire a mine in Indonesia’s Kalimantan region in order to boost production.
Indonesia is the world’s second biggest coal exporter after Australia, but has been hit hard in 2009 by falling export volumes and prices and declining domestic demand. While the government projected earlier this year that domestic consumption would rise by nearly 30%, excess coal supplies mean that most companies will struggle to realize profit growth this year, according to Sylvia Darmaji, a mining sector analyst at PT Ciptadana Securities. Yet Adaro’s marketing director, Alastair Grant, vehemently disagrees, stating that the firm will likely see double-digit growth in both revenue and net profit this year on the back of increased foreign demand, which comprises over 70% of its sales.
Finally, forward thinkers may want to keep an eye on political developments in Australia. The Economist notes this week that coal industry executives there complain that Prime Minister Kevin Rudd’s promise of a carbon-emissions trading scheme would likely mean that Indonesia would be able to undercut Australia in global markets.
Financial Times reported this morning that according to Niu Dun, China’s deputy agriculture minister, Beijing will distance itself from nations such as Saudi Arabia and South Korea by choosing to depend on its own land for self-sufficiency in grain. China is the world’s biggest agricultural economy and its largest consumer and producer of cereals. The growing trend by some to snap up foreign farmland is seen as a response to last year’s spike in agricultural commodity prices and trade restrictions which lead some to question the long term viability of the global food market and to proactively seek alternatives. For example, Pakistan is now offering 1m acres of farmland, to be protected by a special security force, for lease or sale. Gulf Arab nations, heavily reliant on food imports, have reportedly expressed interest.
Marc Faber, the Swiss-born, Thai-based investor known affectionately to many as “Dr. Doom,” remarked to Bloomberg recently that Mongolia is “torn between two lovers – China and Russia,” and is a country with huge potential. “The country is incredibly resource rich, another Saudi Arabia, next to the largest population in the world.”
Earlier this month Mongolia was approved for a $229.2 million stand-by loan from the imf to help the country stabilize its economy. “Mongolia has been severely affected by the global financial crisis through a sharp reduction in the prices of its main mineral exports, notably copper,” said IMF Deputy Managing Director and Acting Chairman Takatoshi Kato. “The authorities are committed to restoring macroeconomic stability and putting in place the conditions for strong and equitable growth.”
Today, however, copper prices rose to its highest in almost six months in London based on speculation that demand from China, the world’s largest buyer of the metal, would decrease inventories. According to Bloomberg, China’s 4 trillion-yuan ($590 billion) economic-stimulus plan spurred the first increase in manufacturing in six months and a sixfold surge in bank lending in March. “Only 2% of global copper reserves are in China, and they can still expect a strong industrial boom for the next couple of years,” remarked one analyst.
Mark Mobius, an emerging market fund manager for Templeton Asset Management, concurs. “We continue to see countries such as China form alliances to secure the long-term provisions of commodities,” Mobius said. “While in the short-term, the country will be impacted by the recent correction in commodity prices, a long-term uptrend in commodity prices will benefit Mongolia.” Additionally, the country has attracted roughly $1 billion of private equity in the past 24 months, according to Robert Lepsoe, its honorary consul.
Mongolia’s MSE Top 20 Index has fallen 8.7% this year, compared with the 5.8% drop in the MSCI Asia Pacific Index.
Despite the global slowdown, not everyone is succumbing to protectionist folly.
China may include further African goods in a list of products excluded from import tariffs in order to further boost trade with the continent. According to state media reports, China already levies no import tariffs on more than 10 types of goods imported from 31 African countries, including textiles, machinery and farm products.
“On the basis of offering zero tariffs for goods from 31 least developed African countries, we will actively consider further expanding the beneficiary scope of African products, and encourage enterprises to favour African goods under the same conditions,” Commerce Minister Chen Deming said.
Is an RMB (yuan) depreciation in the offing? Michael Pettis, a professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets, noted Monday that President Hu Jintao’s speech at this past weekend’s Politburo meeting leaves some wondering.
According to today’s People’s Daily, besides warning “that the global financial turmoil will make it harder for China to maintain the pace of its economic development in the near future”, [Hu] said, in a widely noted comment, that “with the spread of the global financial crisis, China is losing its competitive edge in the world market as international demand is reduced.”
What exactly does this mean? It is worth noting that this has come in the context of recent RMB weakness. According to a Bloomberg piece today, “China’s yuan fell by the most in seven weeks, three days before U.S. Treasury Secretary Henry Paulson visits Beijing for trade talks, on speculation the central bank wants to weaken the currency to spur the economy.” Meanwhile calls for depreciation of the RMB are getting more common, and more and more commentators are beginning to wonder if we might not see a conscious strategy of RMB depreciation.
The yuan has been somewhat of a ‘safe haven’ these past few months, which in turn has helped cushion other regional ‘proxy’ currencies such as TWD, MYR, and HKD. But a weakened yuan, likewise, could cause an exodus of capital that would extend into the other Asian economies.
JGW
Frontier Markets 