Profit as China “irons” out its pricing power
Today's Financial News - Posted May 26, 2009
The commodities markets are getting a lot of attention as investors contemplate an economic rebound. China is the demand leader, but it also owns control of pricing. Its power has created an interesting opportunity.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): If you are studying the commodities markets these days, it is all about China. As the only economy with a shot at strong growth over the next twelve to eighteen months, the country has a certain stronghold on its suppliers.
The big news out of the closely watched industry today is the surprisingly tame deal hashed out between Rio Tinto (NYSE:RTP) and Japan’s Nippon Steel.
If you are not familiar with the steel industry, each year the biggest players sit down and negotiate an annual iron contract. With a historically small spot market for the important metal, forward contracts are the way of the industry.
With the global economy far from what it was just a year ago, commodity investors anxiously awaited this year’s contract figures. After seven years of surging prices, few investors believed the gains could continue.
In fact, the average analyst expected a decline in contract prices somewhere in the range of 30% to 40%. Miners, of course, wanted less. Steelmakers, on the other hand, wanted deep cuts.
In the end, Rio Tinto signed a deal that would lower its overall iron revenues by about 37%.
Japan is happy with the contract, but China wants prices even lower.
As a growing economic power, China is likely to have its way, especially if it sticks to the growing spot market, which currently boasts prices below the levels stated in Rio’s contract.
Changing of the guard
Historically, the iron spot market has been too small and too volatile to safely base a country’s steel market on. But with the growing popularity of paper trades and a strong surge in the spot market (Brazil’s Vale just made its spot market debut), this may be China’s year to overlook locking into 12-month contracts and venture into the world of fluctuating prices.
This could lead to an interesting predicament for the worlds large miners, like Rio Tinto and BHP Billiton (NYSE:BHP).
First off, Rio’s latest contract is estimated to suck some $10 billion in annual revenues from the iron-mining industry. But things could get worse.
If China decides to continue gambling with the spot market and the world’s economy continues its backslide, industry revenues could get hammered, making stakes in the mining industry abnormally risky.
Speculation about a global recovery is on the rise, adding to spot prices, but we all know the bullish trades could dry up with just one ominous headline.
Share prices across the industry are rising today as investors lay their money on the table in hopes prices have reached a bottom. But there is still plenty of negotiating to do with China before anything is a sure thing.
My advice is to take a short-term bearish position in iron miners, especially BHP. As investors realize the future is far from certain and a rosy outlook may be too much to hope for, shares will come under pressure.
The commodities market is going to be strong over the next twelve months, but as power shifts from the supplier to the buyer, the bears will have a shot at taking control.
It is a temporary market glitch, but it can lead to a shot at strong profits for savvy traders. Take advantage of it while you can.
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