China feasts on Canada's resourcesChina feasts on Canada's resources
By JOHN HEINZL
From Saturday's Globe and Mail
When Inco Ltd. opened a sales office in Shanghai a decade ago, the nickel giant's timing couldn't have been more fortuitous.
Back then, China's nickel consumption was still only one-quarter of Japan's. But this year, the emerging economic superpower of 1.3 billion people is poised to overtake the world's second-largest economy, Japan, as the biggest consumer of the metal.
That's significant, because surging demand for nickel — a key ingredient in stainless steel for automobiles, kitchen appliances, electronics and other goods rolling off China's production lines — is a telltale sign of a fast-growing middle class of acquisitive consumers.
China is booming, and nobody knows that better than Canadian resource producers such as Inco. Already the world's sixth-biggest economy, China's share of global output is expected to double by 2020. Its voracious appetite for raw materials such as nickel, copper, zinc, aluminum and coal has pushed commodities prices through the roof and is reawakening Canada's long-sleepy resource sector.
Consider this the next time you fill up: One reason oil has soared to about $40 (U.S.) a barrel is that China is guzzling so much of it.
China's emergence on the world stage is a seismic development, not just for Canada, but for the entire global economy. And it's no passing fad. "This is the biggest event since the United States became an economic power in the post-Civil War period," said Stephen Poloz, senior vice-president and chief economist at Export Development Canada.
But as Chinese-made DVD players and bicycles flood into markets around the world, fears are emerging that its economy, which expanded at a sizzling 9.7-per-cent annualized clip in the first quarter, may be growing too fast. With the Chinese government struggling to find the right mix of measures to prevent the economy from overheating, resource prices have slipped from their peaks and shares of Inco and others have dropped.
So the party's ending, right? Not even close, said Inco chairman and chief executive officer Scott Hand. "In our view, the good times for nickel are far from over," he told the Merrill Lynch Global Metals, Mining and Steel Conference in Boston this month.
Sure, China will hit potholes on the road to prosperity, and those bumps will be felt halfway around the world by Canadian companies and investors. India was a stark reminder of the risks inherent in emerging economies when its stock market plunged about 16 per cent in the two days following this month's election.
But China's evolution into an economic power, and the bull market in commodities it has created, has a long way to go, analysts say.
"As long as one is willing to accept perhaps some additional disappointment in the short run ..... we think commodity prices will rebound as China fears are put into better perspective," said George Vasic, chief economist and strategist at UBS Securities Canada Inc.
In a report this month, titled "Metals: Time to Reload," Mr. Vasic and Jonathan Anderson, UBS's chief economist on China, offer four reasons that the commodities rally has plenty of steam left:
nThe betting is that China's economy can avoid a hard landing.
nIn previous commodities rallies — such as those from 1979 to 1982, 1986 to 1988 and 1993 to 1995 — resource stocks pulled back before resuming their upward march.
nResource stocks have fallen to levels that are now historically cheap relative to their underlying commodities.
nU.S. Treasury yields are rising, and they usually move in tandem with metals prices.
A sustained commodities rally rests on how successful authorities are in managing China's growth.
For the past quarter-century, China's economy has expanded at an average annual rate of nearly 9 per cent, transforming the country into a manufacturing powerhouse that is gobbling up raw materials like Mikey eats Life cereal.
With its vast, low-wage work force, China is now responsible for 30 per cent of global manufacturing output. Last year, it accounted for half of global consumption of cement, 36 per cent of steel and 30 per cent of coal, according to a report from Toronto-Dominion Bank titled Profiting From China's Economic Boom.
"To the extent that Chinese demand continues to push commodity prices higher, China's economic performance will boost earnings of commodity-related companies," said the report by TD economists Craig Alexander and Parhat Zunun.
In Canada, it's hard to find an economic sector that isn't touched by China's dazzling growth. According to Industry Canada, exports to China have soared 75 per cent in the past five years, reaching $4.7-billion (Canadian) in 2003. While that was a small fraction of Canada's total exports of more than $380-billion, the incremental demand from China is having a big impact on a wide swath of resource-based industries.
Take recycled paper. In the past year or so, Chinese buyers have suddenly begun snapping up massive quantities of old newspapers, magazines and corrugated cardboard, which they ship back home and recycle at Chinese paper mills.
"They'll just take everything. They have people on ships who sort it as it is being transported on the boat," said Andrew Casey, a Forest Products Association of Canada spokesman. "It creates a huge challenge for the industry here."
Because Chinese workers get paid a fraction of what Canadian paper sorters earn, Chinese buyers are able to outbid Canadian paper companies for recyclable product, he said. As a result, the price per tonne of recyclable paper soared to a peak of $128 in March from $90 a year ago, he said.
Steel prices are also up sharply because of Chinese demand, benefiting producers such as Dofasco Inc., Algoma Steel Inc. and Stelco Inc.
China has also developed an appetite for Canadian seafood. Frozen shrimps and prawns are one of Canada's fastest-growing exports to China, with shipments climbing eightfold in the past five years to $104-million in 2003.
"It's grown very dramatically. If you go back six or seven years, China did not import one single ounce of cold-water shrimp," said Randy Bishop, vice-president of international sales and marketing at St. John's-based FPI Ltd.., which also exports snow crab, sea scallops and other products to China.
Clearwater Fine Foods Inc. of Bedford, N.S., with 30 per cent of its sales going to Asia, is also heavily targeting the Chinese market.
Exports of auto parts, lumber and assorted chemicals have also risen sharply in recent years, Industry Canada says. Norske Skog Canada Ltd., for instance, said its pulp business during the first quarter was "brisk ..... stemming largely from solid demand from Chinese buyers and tighter supply."
And Tesma International Inc. plans to open a factory in China this year to supply the country's burgeoning auto industry. Tesma, which is controlled by Magna International Inc. of Aurora, Ont., will make engine belt tensioners for Volkswagen AG.
With Canada's economy forging closer ties to China, how events unfold over there will be critical for companies here. For Chinese authorities, the challenge is to tame the runaway growth without tipping the country into recession.
"It is like riding a bicycle — the rider needs momentum to stay upright, but too much raises the risk of a crash," said Mr. Poloz of EDC.
China's central bank is concerned that white-hot growth will ignite inflation, which climbed to a seven-year high of 3.8 per cent in the year to April 30. The bank is also worried that the high volume of bad loans within the financial system, estimated to range from 20 per cent to as high as 40 per cent, will contribute to a boom-bust scenario.
In a bid to prevent the bubble from bursting, China's central bank has raised reserve requirements for banks and announced restrictions on investments in some of the fastest-growing sectors, such as real estate, auto production and steel. As well, it raised the discount rate it charges banks for loans. Complicating matters, however, the central bank pegs its currency, the yuan, to the U.S. dollar, which limits its domestic policy options.
"The Chinese central bank is trying to engineer a soft landing, and if it's successful this will just be a hiccup," said Eric Roseman, president of ENR Asset Management Inc. in Montreal, which manages money for clients outside Canada.
"If it's not successful and you go from boom to bust ..... it will be a disaster for the Chinese markets, it will be a disaster for Chinese real estate and it will be a disaster for global commodities."
That will slam Canadian corporate earnings, the Canadian dollar and the Toronto Stock Exchange, he said. But he considers the probability of a meltdown remote.
Yanick Desnoyers, senior economist at National Bank Financial, said the situation today is different from China's last bust in the early 1990s, when growth was 15 per cent, inflation 25 per cent and the country was running large current account deficits, in contrast to today's surplus.
"Inflation is not currently in runaway mode," he said. "We think the financial markets are spooking too soon."
Inco's Mr. Hand is also optimistic. He expects China to consume five million tonnes of stainless steel this year. That would still be just one-third of the average per capita consumption of Western countries — leaving plenty of room for growth.
Nickel demand will get an added boost from the 2008 Summer Olympics in Beijing, he said. For Inco, there is little time to rest.
"We are producing every pound of profitable nickel that we can," he said.
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1.3 BILLION: China's Population
75%: Growth in Canada's Exports to China from 1999 to 2003
$201.6 MILLION: Value of artificial Christmas trees and ornaments imported by Canada from China last year.
50%: Share of Global Cement production consumed by China last year.
China GDP
Annual percentage increase in China's gross domestic product
1999: 7.1%
2000: 8.0%
2001: 7.5%
2002: 8.0%
2003: 9.1%
The Trade Balance
Canada's exports to China in billions of Canadian dollars
1999: 2.7%
2000: 3.7%
2001: 4.3%
2002: 4.1%
2003: 4.7%