The 3 Killer Cs - Cyclical, Capital-intensive and Commoditised

"The 3 Killer Cs"

Not one but three 'killer Cs' lurk around the darkest corners of the business world. 

If any one of them grips a business, it makes life hell for the managers and profits elusive for the owners. What are they? 

The first is 'cyclical'. 

• When a business is cyclical, it sees large and unpredictable swings in its revenues, margins, and profits. Everything that matters is all over the place. 

The second is 'capital-intensive'. 

• Businesses afflicted by high capital-intensity require a lot to produce little. They s u  c k investors dry as they need large amounts of capital to make profits. 

The third is 'commoditised'. 

• Companies here can do very little to prove to customers that their product or service is better than their competitor's. 

The presence of even one of these killer Cs is bad news for a business. 

Price Competition

1.  Highly competitive industry (commodity products)

• Industries in which price is the most significant consideration in customers' purchase decisions tend to be highly competitive.
• A slight increase in price may cause customers to switch to substitute products if they are widely available.

2.  Franchise industry (franchise products)

• Price is not as important if companies in an industry are able to effectively differentiate their products in terms of quality and performance.  
• Customers may not focus on price as much if product reliability is more important to them.

Characteristics of Commodity and Cyclical companies and their Value Drivers.

Characteristics of commodity and cyclical companies

            While commodity companies can range the spectrum from food grains to precious metals and cyclical firms can be in diverse business, they do share some common factors that can affect both how we view them and the values we assign to them.

1. The Economic/Commodity price cycle: Cyclical companies are at the mercy of the economic cycle. While it is true that good management and the right strategic and business choices can make some cyclical firms less exposed to movements in the economy, the odds are high that all cyclical companies will see revenues decrease in the face of a significant economic downturn. Unlike firms in many other businesses, commodity companies are, for the most part, price takers. In other words, even the largest oil companies have to sell their output at the prevailing market price. Not surprisingly, the revenues of commodity companies will be heavily impacted by the commodity price. In fact, as commodity companies mature and output levels off, almost all of the variance in revenues can be traced to where we are in the commodity price cycle. When commodity prices are on the upswing, all companies that produce that commodity benefit, whereas during a downturn, even the best companies in the business will see the effects on operations.
2. Volatile earnings and cash flows: The volatility in revenues at cyclical and commodity companies will be magnified at the operating income level because these companies tend to have high operating leverage (high fixed costs). Thus, commodity companies may have to keep mines (mining), reserves (oil) and fields (agricultural) operating even during low points in price cycles, because the costs of shutting down and reopening operations can be prohibitive.
3. Volatility in earnings flows into volatility in equity values and debt ratios: While this does not have to apply for all cyclical and commodity companies, the large infrastructure investments that are needed to get these firms started has led many of them to be significant users of debt financing. Thus, the volatility in operating income that we referenced earlier, manifests itself in even greater swing in net income.
4. Even the healthiest firms can be put at risk if macro move is very negative: Building on the theme that cyclical and commodity companies are exposed to cyclical risk over which they have little control and that this risk can be magnified as we move down the income statement, resulting in high volatility in net income, even for the healthiest and most mature firms in the sector, it is easy to see why we have to be more concerned about distress and survival with cyclical and commodity firms than with most others. An extended economic downturn or a lengthy phase of low commodity prices can put most of these companies at risk.
5. Finite resources: With commodity companies, there is one final shared characteristic. There is a finite quantity of natural resources on the planet; if oil prices increase, we can explore for more oil but we cannot create oil. When valuing commodity companies, this will not only play a role in what our forecasts of future commodity prices will be but may also operate as a constraint on our normal practice of assuming perpetual growth (in our terminal value computations).

In summary, then, when valuing commodity and cyclical companies, we have to grapple with the consequences of economic and commodity price cycles and how shifts in these cycles will affect revenues and earnings. We also have to come up with ways of dealing with the possibility of distress, induced not by bad management decisions or firm specific choices, but by macro economic forces.

Commodity and Cyclical companies: Value Drivers

Normalized Earnings

If we accept the proposition that normalized earnings and cash flows have a subjective component to them, we can begin to lay out procedures for estimating them for individual companies. With cyclical companies, there are usually three standard techniques that are employed for normalizing earnings and cash flows:

1.     Absolute average over time: The most common approach used to normalize numbers is to average them over time, though over what period remains in dispute. At least in theory, the averaging should occur over a period long enough to cover an entire cycle. In chapter 8, we noted that economic cycles, even in mature economies like the United States, can range from short periods (2-3 years) to very long ones (more than 10 years). The advantage of the approach is its simplicity. The disadvantage is that the use of absolute numbers over time can lead to normalized values being misestimated for any firm that changed its size over the normalization period.  In other words, using the average earnings over the last 5 years as the normalized earnings for a firm that doubled its revenues over that period will understate the true earnings.

2.     Relative average over time: A simple solution to the scaling problem is to compute averages for a scaled version of the variable over time. In effect, we can average profit margins over time, instead of net profits, and apply the average profit margin to revenues in the most recent period to estimate normalized earnings. We can employ the same tactics with capital expenditures and working capital, by looking at ratios of revenue or book capital over time, rather than the absolute values.

3.     Sector averages: In the first two approaches to normalization, we are dependent upon the company having a long history. For cyclical firms with limited history or a history of operating changes, it may make more sense to look at sector averages to normalize. Thus, we will compute operating margins for all steel companies across the cycle and use the average margin to estimate operating income for an individual steel company. The biggest advantage of the approach is that sector margins tend to be less volatile than individual company margins, but this approach will also fail to incorporate the characteristics (operating efficiencies or inefficiencies) that may lead a firm to be different from the rest of the sector.

Normalized commodity prices

            What is a normalized price for oil? Or gold? There are two ways of answering this question.

1.     One is to look at history. Commodities have a long trading history and we can use the historical price data to come up with an average, which we can then adjust for inflation. Implicitly, we are assuming that the average inflation-adjusted price over a long period of history is the best estimate of the normalized price.

2.     The other approach is more complicated. Since the price of a commodity is a function of demand and supply for that commodity, we can assess (or at least try to assess the determinants of that demand and supply) and try to come up with an intrinsic value for the commodity.

Once we have normalized the price of the commodity, we can then assess what the revenues, earnings and cashflows would have been for the company being valued at that normalized price. With revenues and earnings, this may just require multiplying the number of units sold at the normalized price and making reasonable assumptions about costs. With reinvestment and cost of financing, it will require some subjective judgments on how much (if any) the reinvestment and cost of funding numbers would have changed at the normalized price.

            Using a normalized commodity price to value a commodity company does expose us to the critique that the valuations we obtain will reflect our commodity price views as much as they do our views on the company. For instance, assume that the current oil price is $45 and that we use a normalized oil price of $100 to value an oil company. We are likely to find the company to be undervalued, simply because of our view about the normalized oil price. If we want to remove our views of commodity prices from valuations of commodity companies, the safest way to do this is to use market-based prices for the commodity in our forecasts. Since most commodities have forward and futures markets, we can use the prices for these markets to estimate cash flows in the next few years. For an oil company, then, we will use today's oil prices to estimate cash flows for the current year and the expected oil prices (from the forward and futures markets) to estimate expected cash flows in future periods. The advantage of this approach is that it comes with a built-in mechanism for hedging against commodity price risk. An investor who believes that a company is under valued but is shaky on what will happen to commodity prices in the future can buy stock in the company and sell oil price futures to protect herself against adverse price movements.

Little Book of Valuation

Aswath Damodaran

Huge sell-off in agriculture as speculators run

October 2, 2010

Fear of high corn stockpiles and uncertainties in the outlook for sugar and cotton sparked a massive sell-off in agricultural markets on Friday, overshadowing the rally in energy and metals.

US corn futures tumbled the 30-cent trading limit in near record volume to end down 6 per cent for the session and 10 per cent for the week in an extended reaction to Thursday's government crop report showing hefty inventories of the grain.

Soybeans fell 4 per cent on the day and wheat over 3 per cent.

Raw sugar closed down half a per cent, adding to the previous session's drop of almost 6 per cent. Analysts said investors were worried the sweetener's near 50 per cent gain during the third quarter had outpaced demand.

The liquidation marked a sharp reversal in trend for agricultural markets, which were among the biggest gainers in commodities during the just-ended quarter.

"I'm sure that the market had outstripped its fundamentals," Keith Brown, a cotton broker in Moultrie, Georgia, said after US cotton futures plunged about 4 per cent from 15-year highs. "(Speculators) carried us up ... now, they are feeding upon themselves like piranha trying to get out faster than the next guy."

The 19-commodity Reuters-Jefferies CRB index settled down almost half per cent after rising as much earlier in the session, following a 2 per cent rally in oil and copper and a new record high in gold. The CRB rose nearly 11 per cent in the third quarter, its biggest gain in five quarters, with sugar being the index's star performer.

The about-face in agriculture after the strong third quarter made some grains traders wonder if they were looking at the start of a prolonged lean period for prices. But some, like those in the sugar trade, expected a quick rebound.

"With oil so strong and the dollar weakening further, it would seem sugar will hold rather than continue the collapse, and we would expect the support to hold," said Thomas Kujawa of Sucden Financial Sugar, who predicted the sweetener would hold at above 22.50 cents a lb. New York's key raw sugar contract closed at 23.36 cents per lb.

Corn posted its biggest one-day drop since January 12, when the government released another bearish report on stockpiles of the grain. Chicago's key corn contract for December finished at $US4.65-3/4 a bushel, falling the 30 cent that also contributed to its biggest weekly loss since mid-January.

Crude oil's benchmark front-month contract in New York rose almost 2 per cent to settle above $US81 a barrel, a level not seen since August 10, as a sliding dollar caused investors to hedge in oil and metals.

Gold hit record highs for a sixth successive session, scaling above $US1320 per ounce.

Copper rose 2 per cent to scale two-year highs in both London and New York after China's latest manufacturing data showed an important engine of global growth was humming again after sputtering in the second quarter.

Reuters

http://www.smh.com.au/business/markets/huge-selloff-in-agriculture-as-speculators-run-20101002-161g3.html

Traders bet on continuing stock market rally

Traders bet on continuing stock market rally
The recent stock market rally could continue this week, as traders increase their bullish positions in a wide range of asset classes.

By Garry White
Published: 11:07PM BST 02 Aug 2009

The FTSE 100 had its best month in more than six years in July, boosted by a number of better-than-expected corporate earnings releases and hopes that the worst of the recession was now over. Derivatives traders are now betting that improving conditions would result in further price rises in metals and soft commodities.

Commodity prices have risen sharply this month after economic data improved and the dollar slid to its lowest level in 2009 – and further rises are now expected.


Related Articles
FTSE 100 closes at year high
FTSE 100 hits new high for year
Commodity prices set to rise further, Roubini says

The copper price, which is seen as a leading indicator of future economic growth, rose for a seventh-straight month over the course of July. Aluminium prices put in their highest monthly gain since 1988.

The FTSE 100 is heavily exposed to mining and oil groups, with about 30pc of its weighting made up by global commodity plays such as BHP Billiton, BP and Fresnillo.

Last week, earnings reports from the likes of AstraZeneca, Pearson and Cadburys pleased as cost-cutting measures made businesses leaner and positioned them well for an economic upturn.

There is the potential for any rally to derail, however, as earnings are released this week by the major UK banks and insurers.

However, US derivative traders and hedge funds have bet that the recent rally in many asset classes will continue, data from the US Commodity Futures Trading Commission (CFTC) reveal.

In the week to July 28, traders increased bets that the price of a wide range of commodities will continue to rise. When more traders are using futures contracts to bet on a price rise than on a price fall a so-called "net long" position is created.

Last week an increase in the net long position was seen in a wide range of contracts, including crude oil, heating oil, platinum, orange juice, cocoa, sugar, corn, hogs, soymeal, cattle and silver, while the net short position in copper, which means more traders expect a fall in prices than expect a rise, was reduced. Bets on a rise in the cotton and gold price fell slightly.

The data was compiled before Friday's positive reading on US second-quarter GDP, which fell 1pc year-on-year compared with expectations of a 1.5pc fall.

"The outlook for base metal prices is growing more positive," says Gayle Berry, an analyst at Barclays Capital. However, she thinks that Chinese buying of copper is likely to moderate in the second half of the year, after the country's imports doubled in the first half.

The FTSE 100 index of leading shares climbed 8.5pc in July, adding £134bn to the value of the stock market.

http://www.telegraph.co.uk/finance/markets/5961931/Traders-bet-on-continuing-stock-market-rally.html

Commodity prices set to rise further, Roubini says

Commodity prices set to rise further, Roubini says
Commodity prices may extend their rally in 2010 as the global recession abates, said Nouriel Roubini, the New York University economist who predicted the financial crisis.

By Bloomberg
Published: 7:13AM BST 03 Aug 2009


Nouriel Roubini predicted the current financial crisis. “As the global economy goes toward growth as opposed to a recession, you are going to see further increases in commodity prices especially next year,” Roubini said today at the Diggers and Dealers mining conference in Kalgoorlie, Western Australia. “There is now potentially light at the end of the tunnel.”

Roubini, chairman of Roubini Global Economics and a professor at NYU’s Stern School of Business, joins former Federal Reserve Chairman Alan Greenspan in seeing signs of recovery. Commodity prices gained the most in more than four months on July 30 as investors speculated that the worst of the global recession has passed and consumption of crops, metals and fuel will rebound.


Related Articles
Euro bank's hawks take a pounding
Europe and Asia face hard landings as bubbles burst
Credit crisis: now a 'strong chance' UK will enter a recession
OECD warns global jobless to rise by 25 million
Bank crisis ends as the economic crisis begins

“The things he was saying provide good indicators for our business,” Martin McDermott, a manager for metals project development at SNC-Lavalin Group Inc., Canada’s biggest engineering and construction company, said at the conference.

“The commodities that we’re involved with, being copper, nickel, gold, iron ore, all seem to have positive signs and we hope to take advantage of that.”

Greenspan said yesterday the most severe recession in the U.S. in at least five decades may be ending and growth may resume at a rate faster than most economists foresee. Oil has jumped 56 percent in 2009 and copper has surged 86 percent.

Roubini predicted on July 23 that the global economy will begin recovering near the end of 2009, before possibly dropping back into a recession by late 2010 or 2011 because of rising government debt, higher oil prices and a lack of job growth.

Economic growth in China, the world’s biggest metals consumer, accelerated in the second quarter, gaining 7.9 percent from a year earlier. China, the biggest contributor to global growth, overtook Japan as the world’s second-largest stock market by value on July 16 after the nation’s 4 trillion yuan ($585 billion) stimulus package spurred record lending and boosted prices of shares and commodities.

China will meet its target of 8 percent growth in gross domestic product this year, Roubini said. Manufacturing in China climbed for a fifth month in July as stimulus spending and subsidies for consumer purchases countered a collapse in exports, and helped companies from chipmaker Semiconductor Manufacturing International Corp. to automaker General Motors Corp. as well as mining companies such as BHP Billiton Ltd. and Rio Tinto Group.

China’s official Purchasing Managers’ Index rose to a seasonally adjusted 53.3 in July from 53.2 in June. A reading above 50 indicates an expansion. The manufacturing index has climbed from a record low of 38.8 in November.

A rise in commodity prices may help the Australian dollar, Roubini said today, adding he is “bullish” on the currency. Countries including Australia, New Zealand and Canada have so-called commodity currencies because raw materials generate more than 50 percent of their export revenues.

The Australian dollar today rose to the highest since September before retail sales and house price data tomorrow that may add to evidence the nation’s economy will rebound faster than the central bank forecast six months ago.

The price of aluminum, used in beverage cans and airplane parts, has declined by a third in the past year as the global recession crimped demand. A recovery in demand may be offset by the “huge amount of excess capacity,” which could be a risk to the price, Roubini said.

The Reuters/Jefferies CRB Index of 19 commodities has risen 12 percent this year. It jumped 3.9 percent on July 30 to 253.14,the biggest gain since March 19.

“That recovery will continue slowly, slowly over time,” Roubini said today. The global economy may contract 2 percent this year and swing to growth of 2.3 percent next year, he said.

Vale SA, the world’s biggest iron ore producer, said demand for metals is starting to recover and it will begin boosting output. Vale Chief Financial Officer Fabio Barbosa said on July 30 that “the worst is over”.

The price of oil may rise more than other commodities because of an expected rebound in demand, Roubini said separately in an interview with Bloomberg News. It may average between $70 and $75 a barrel next year, he said.

Crude oil traded above $70 a barrel today for the first time in a month on speculation fuel demand will increase, amid signs the global economy is recovering from recession.

The U.S. economy, the world’s biggest, is likely to grow about 1 percent in the next two years, less than the 3 percent “trend,” Roubini said last month. President Barack Obama said on July 30 the U.S. may be seeing the beginning of the end of the recession.

In July 2006 Roubini predicted the financial crisis. In February of last year he forecast a “catastrophic” meltdown that central bankers would fail to prevent, leading to the bankruptcy of large banks with mortgage holdings and a “sharp drop” in equities. Since then, Bear Stearns Cos. was forced into a sale and Lehman Brothers Holdings Inc. went bankrupt, prompting banks to hoard cash and depriving businesses and households of access to capital.

http://www.telegraph.co.uk/finance/markets/5963702/Commodity-prices-set-to-rise-further-Roubini-says.html

Commodity prices climb on economic recovery hopes

Agence France-Presse - 5/8/2009 5:14 PM GMT

Commodity prices climb on economic recovery hopes

Commodity prices rallied this week, with oil striking 2009 highs on growing optimism about an economic recovery, as traders also tracked the results of key "stress tests" on troubled US banks.

"Commodity index returns have rebounded over the past week," said Deutsche Bank analyst Michael Lewis in a research note to clients.

"In our view, this reflects the market's less pessimistic assessment towards the global growth outlook. However, in most instances index returns are still trading lower on a year to date basis."

Financial markets appeared unruffled by the stress tests, which found that 10 major US banks need to raise a total of 74.6 billion dollars (55.7 billion euros) in new funds to shield against the risk of a further economic downturn.

Official data showed Friday that the US unemployment rate rose to 8.9 percent in April with 539,000 jobs lost, according to a report which was not as bad as feared by private analysts for the recession-stricken economy.

The jobless rate hit its highest level since September 1983 but the pace of job losses slowed appreciably, offering another possible sign of an easing of the severe economic slump.

The unemployment rate was in line with forecasts but the number of job losses not nearly as bad as the consensus Wall Street estimate of 600,000.

Earlier this week, a survey by payrolls firm ADP data showed that the US private sector shed 491,000 jobs in April, which was much lower than analysts had forecast.

OIL: Prices rocketed to near six-month highs above 58 dollars per barrel as stock markets gained on increasing signs of economic recovery in the United States, the world's biggest energy consumer.

"Crude oil prices are being driven higher by a combination of building confidence of a faster economic recovery, increased funds flow into commodities, and higher utilisation at US refineries," said Lewis.

"However we believe the fundamental outlook remains weak and that inventories are set to remain high."

Prices have posted solid gains this week on hopes of a recovery in energy demand, but they remain far below last July's record peaks above 147 dollars a barrel.

"Oil prices have been surging this week on titbits of information indicating that the economic crisis has reached its trough and that recovery could be around the corner," said analysts at JBC Energy.

"US banks appear to be doing better than everybody thought according to the Fed's preliminary release on the stress test, while the rate of job losses in the country has slowed.

"In the wider picture there are also tentative signs that economic activity in China and India has been picking up with Chinese manufacturing having accelerated for the first time in nine months.

"The Baltic Dry Index also surged by 8.9 percent, day-on-day, and was last seen at over 2,000 points; the Index is a daily average of the costs of shipping raw materials to end customers and so can be seen as a good barometer of the health of the world economy," added the JBC analysts in a research note.

However Nimit Khamar at the Sucden brokerage in London warned that oil prices could head lower in coming weeks should investors begin to show less optimism regarding an economic recovery.

By Friday, on the New York Mercantile Exchange (NYMEX), light sweet crude for delivery in June surged to 57.60 dollars a barrel from 52.11 dollars a week earlier.

On London's InterContinental Exchange (ICE), Brent North Sea crude for June soared to 57.28 dollars a barrel from 51.63 dollars a week earlier.

PRECIOUS METALS: Precious metals sparkled, with gold hitting 925 dollars per ounce on Thursday, drawing strength from the weak US currency.

A struggling greenback makes dollar-priced commodities cheaper for foreign buyers using stronger currencies -- and therefore tends to stimulate demand.

By late Friday on the London Bullion Market, gold rose to 907 dollars an ounce from 884.50 dollars the previous week.

Silver advanced to 13.90 dollars an ounce from 12.15 dollars.

On the London Platinum and Palladium Market, platinum increased to 1,149 dollars an ounce at the late fixing on Friday from 1,076 dollars.

Palladium leapt to 242 dollars an ounce from 212 dollars.

BASE METALS: Base metals prices soared on hopes that a global economic recovery would boost demand.

"Prices strengthened across the complex... as sentiment was boosted by a higher than expected figure for US employment data offering further evidence that the macro outlook may be beginning to improve," said Barclays Capital analysts.

"Sentiment towards the broader global macro outlook has been turning more positive recently and this is being reflected in base metals prices."

By Friday on the London Metal Exchange, copper for delivery in three months climbed to 4,763 dollars a tonne from 4,515 dollars the previous week.

Three-month aluminium jumped to 1,564 dollars a tonne from 1,518 dollars.

Three-month lead rose to 1,484 dollars a tonne from 1,356 dollars.

Three-month tin surged to 14,214 dollars a tonne from 12,475 dollars.

Three-month zinc increased to 1,557 dollars a tonne from 1,475 dollars.

Three-month nickel rallied to 13,303 dollars a tonne from 11,725 dollars.

COCOA: Cocoa prices advanced on signs of strengthening demand.

By Friday on LIFFE, London's futures exchange, the price of cocoa for delivery in July rose to 1,751 pounds a tonne from 1,703 pounds the previous week.

On the New York Board of Trade (NYBOT), the July cocoa contract gained to 2,507 dollars a tonne from 2,388 dollars.

COFFEE: Coffee prices also climbed, hitting 125.80 US cents per pound in New York -- a level last seen on February 9.

By Friday on LIFFE, Robusta for delivery in July increased to 1,493 dollars a tonne from 1,475 dollars the previous week.

On the NYBOT, Arabica for July stood at 125.20 US cents a pound from 116.35 cents.

GRAINS AND SOYA: Prices gained ground amid production delays and higher crude oil prices. Corn, or maize, is used to produce ethanol -- a clean plant-based fuel which is cheaper than oil.

"Support for corn prices stems from delays in corn plantings especially in the eastern US corn belt, as well as the strong rise in crude oil prices," said Barclays Capital analysts.

By Friday on the Chicago Board of Trade, maize for delivery in July rose to 4.19 dollars a bushel from 4.13 dollars the previous week.

July-dated soyabean meal -- used in animal feed -- gained to 11.04 dollars from 10.91 dollars.

Wheat for July advanced to 5.80 dollars a bushel from 5.70 dollars.

SUGAR: Sugar prices surged close to a three-year peaks, stretching as high as 452.20 pounds in London and 15.60 cents in New York -- the highest points since July 2006.

"Sugar prices have shot higher on an anticipated tightening of stocks in India and on supportive developments in the biofuel industry in the United States," said Standard Chartered analysts.

Sugar is used to make ethanol, a cheaper alternative to gasoline used to power road vehicles.

By Friday on LIFFE, the price of a tonne of white sugar for delivery in August rose to 445.90 pounds from 431.80 pounds the previous week.

On NYBOT, the price of unrefined sugar for July increased to 15.37 US cents a pound from 14.47 cents.

RUBBER: Malaysian rubber prices tracked rising oil prices to close higher Friday.

Traders said the rubber price was also benefitting from tight supply. The price of natural rubber is linked with the cost of crude oil, which affects the price of synthetic rubber products.

The Malaysian Rubber Board's benchmark SMR20 was at 165.90 US cents per kilo, compared to 157.15 US cents on April 30.

burs-rfj/rlp

The Dragon is blowing commodity bubbles

From Times Online
January 7, 2009

The Dragon is blowing commodity bubbles: Leo Lewis on Asia

Bullish little oddities have been surfacing across Asia, and in the background are the hunger pangs of the Dragon Leo Lewis, Asia Business Correspondent

Yesterday, after three consecutive sessions of hot-blooded, limit-hitting exuberance, trading in Shanghai rubber futures was suspended and given the chance to simmer down. Dealers simply shrugged and made a feverish lunge for Tokyo rubber futures instead.

It was not supposed to be like this. Everyone has seen the doom-laden pictures by now - the trade fleets at anchor, the silent pit-heads and the stone-cold blast furnaces – but risk capital seems to have spotted something more enticing: six vast holes in the ground and the contents of a Chinese fridge.

Accordingly, dozens of other bullish little oddities have begun surfacing in what were supposed to be dread-infested markets. In Seoul, shares in the country’s two largest fisheries lurched around 8 per cent higher yesterday, because a woman died of bird flu in Beijing and a panicky cull of poultry may be in the offing.

In Kuala Lumpur, plantation owners are celebrating a flying start to the New Year after the prospect of widespread frying drove an extended rally in palm oil. South American soy bean farmers are expecting weekly orders to double from normal levels. Energy traders in Singapore are beginning to mutter quietly about a solid floor on crude oil prices.

Related Links
Tokyo stock market ends year of decline
Tokyo markets close on 42% annual fall
Playing in the background to all of this is a seductive, hypnotising ode: The hunger pangs of the Dragon.

As tunes go, this is a siren-call with monstrously good form. Few bubble-inflating puffs of broker-patter have moved so many markets by so much and in such a short space of time as the great “China eats the world” theory. Three years ago, when this argument was in its most impressive stage of ascendancy, it could be attached to nearly every call. Given all the capital which, at the time, needed somewhere to go, the line was guaranteed an attentive audience. The following sentence could be adapted for purpose: “Quake with fear, because the Chinese are drinking/eating/building/burning/stir-frying/smelting ever more copper/concrete/indium/phosphorus/condominiums/steel/pork/milk/corn – and will continue to do so for five years/a decade/fifty years/until the world runs out completely.”

Endless charts could be produced showing Chinese hard and soft commodity consumption doubling over the previous decade and China’s relative proportion of total global consumption soaring with it. Beijing itself was talking with bullet-proof confidence about the millions of people it had lifted from poverty, and it was hard not to be convinced that the charts would simply continue northwards.

That view took a bit of a breather as the global economy drooped, but now, far, far sooner than expected, the “China eats the world” theory has returned to markets and begun playing its old mind tricks once again.

There is a subtle difference this time, though: in a year where nothing can be reasonably expected to boom the appetite argument rests on the sense that Beijing is exploiting both its relatively low debt position and the immense recent plunges in commodity prices to cheaply stockpile resources for the future – a move that analysts agree makes eminent good sense both for China, and for any big companies out there with enough cash to take similar advantage from the situation. For a nation that has pinned its hopes for economic stimulus on multi-billion dollar infrastructure projects, the state has a clear interest in securing the raw materials at their current knock-down prices. The Chinese leadership has also made little secret of its concerns about preserving social stability as the mighty manufacturing growth engine sputters. If the opportunity is there, state purchases of grains, metals, energy and anything else with inherent price volatility are a natural buffer for a state to establish against future public unrest.

To help things along, China’s actual intentions remain tantalisingly vague. Energy analysts in London believe that China is currently looking to fill six newly-built strategic petroleum reserves dotted around the country with a view to securing a stockpile of some 250 million barrels of crude. Agricultural commodity traders believe that the state is looking to replenish its grain and soybean reserves – depleted after years of draw-down, while metal traders have heard that China is planning secure stocks of a variety of minerals from aluminium and copper to nickel and zinc.

Unfortunately, all the recent price spikes based on this have the clammy feel of a sucker’s rally. Compared with its former gluttony, the Dragon is scarcely more than peckish: look behind the China voracity theory this time, and it is riddled with flaws. Those crude oil storage facilities may indeed be deep and empty, but even if you assume that the job of filling them adds 100,000 barrels to overall daily Chinese imports of 8 million barrels, the practical impact on global demand is negligible. It is certainly no counterweight to a global plunge in demand measured in the tens of millions of barrels.

Similarly with metals, no amount of state buying – even in the form of offering liquidity to local smelters – is going to compensate for the sort of drop-off in industrial production and manufacturing experienced over the last couple of months. Even the promise of massive infrastructure projects implied by Beijing’s $580 billion stimulus package will affect only about 16 per cent of the economy, and a state think tank said yesterday that the country’s fixed-asset investment would decelerate in 2009 despite all those new spending plans.

Even the more literal image of China eating the world may fade for at least another year or two until the factories start whirring again. The prices of edible oils and other foods are now performing strongly ahead of the Lunar New Year holidays, but it takes a considerable leap of faith to imagine that Chinese demand for meat, dairy products and cooking oils will be back at global larder-sapping levels come mid-February.


http://business.timesonline.co.uk/tol/business/markets/article5467895.ece