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Making nickel pig iron at a plant in in Huaibei, China. (Andy Hoffman/The Globe and Mail)
Making nickel pig iron at a plant in in Huaibei, China. (Andy Hoffman/The Globe and Mail)

China prepares strategically for downturn Add to ...

China is cutting back on its commodities binge through a series of recent investment choices that signal a change in strategy as its economy slows.

In the past few weeks, China has pulled out of mining deals, curbed production, let stockpiles sink, expanded a resources tax and announced gold will not be a key investment for its foreign exchange reserves.

That is on top of larger economic measures taken to cool its property market and lending activity, while taking steps to let its currency appreciate.

The moves are consistent with a country that is preparing for a downturn once its stimulus spending runs out, which could hit commodities hard, analysts say.

"We anticipate a soft landing for the economy, but a harder landing for commodity intensive demand," UBS said in a recent report on China.

The impact of China's slowing economy is already weighing heavily on key commodities such as copper, aluminum, nickel, zinc and lead, all of which have fallen by between about 15 and 25 per cent since April, when they hit highs not seen since before the global economic meltdown.

Europe's debt woes are partly to blame for the price drops, but China - which consumes about 40 per cent of the world's main base metals - has a much stronger influence. It was China's voracious appetite for commodities that helped pull the global economy out of the recent recession.



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But now, fears of a double dip recession are mounting as commodity prices fail to bounce back, and consumer spending in China starts to slip. China is slowly unveiling how it plans to manage what economists forecast is an inevitable economic cool down following double-digit growth in the first quarter.

For example, some state-owned Chinese firms have reversed investment decisions in recent weeks, citing falling commodity prices and increased costs for projects they vigorously pursued a few months earlier.

In mid-June, China's utility giant State Grid International Development Ltd. backed out of a $1-billion joint-venture agreement with Vancouver-based miner Quadra FNX Ltd. to develop copper projects in Chile. The deal was signed in March, as copper prices were climbing, but fell apart in June after they had fallen by about 20 per cent.

Days later, China's largest gold miner Zijin cancelled a takeover offer for Australian mineral explorer Indophil that would give it access to a copper-gold project in the Philippines.

And earlier this month, Aluminum Corp. of China, also known as Chinalco, terminated an agreement to build an alumina complex in Australia. The company said lower commodity prices and higher costs led to the decision.

While China has pulled back from some projects, its "strategic focus" in the medium term will be on expanding direct foreign investment in certain key resource projects, according to Patricia Mohr, commodity market specialist with the Bank of Nova Scotia.

Take for instance Chinalco's declared interest in investing in the massive Oyu Tolgoi copper project in nearby Mongolia, which is owned by Ivanhoe Mines Ltd. and Rio Tinto PLC.

China's growth is slowing, but Ms. Mohr said it still needs to ensure "security of supply" for its industry and its expansion, albeit at a slower pace than in recent months.

Scotiabank economists recently maintained their forecast for 10-per-cent growth in China this year, before falling next year, citing credit restraint measures that starting to curb spending.

"The combination of gradual domestic restraint and reduced export growth attributable to the slower pace of growth in the advanced economies should result in China's output expanding by an average of 9 per cent in 2011," Scotiabank said in a recent report.

Part of China's strategy appears to be ramping up domestic production of key commodities it requires and slowing imports.

The next step is production cuts, which analysts say have already begun in China's steel industry.

"Production cuts are expected for some in the coming months, and we are likely to see apparent consumption slow in line with broader macro economic indicators," Macquarie Group said in a recent report. "While production has been strong over the first five months of 2010, the sharp drop in prices over June could lead to production of several commodities being cut back."



Thinking ahead

China's strategic moves heading into a post-stimulus economy:



MINING DEALS



China has pulled out of several mining deals, citing falling commodity prices and higher project costs. Recent examples include:



State Grid International Development Ltd. ends $1-billion joint-venture agreement with Vancouver-based miner Quadra FNX Ltd. to develop copper projects in Chile. Deal signed in March, when copper prices were rising and hit about $3.60 per pound in early April. They have since fallen to around $3.



China's largest gold miner Zijin pulls takeover offer for Australian mineral explorer Indophil that would give it access to a copper-gold project in the Philippines, citing "uncertainties" around getting the project off the ground.



Aluminum Corp. of China, also known as Chinalco, ends agreement to build an alumina complex in Australia, citing lower commodity prices and higher costs led to the decision.



GOLD



China's State Administration of Foreign Exchange said recently that there are limits to investing in gold and that it "cannot become a main channel for investing our foreign exchange reserves," citing the limited size of the gold market. If China were to buy more gold, it would cause prices to rise. "That will eventually hurt the interest of Chinese consumers," the agency said in a statement.



RESOURCES TAX



China is considering extending a 5-per-cent resource tax across the country that would include coal. The tax began in part of the country in June on crude and natural gas.



Source: Staff, Reuters

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