China's Industrialisation Update

Submitted by Jim Thesiger on 26 May, 2008 - 17:30

Here is an update on China’s Industrialisation from market analyst Macquarie Research Equities.

China’s Industrialisation: Resources Strong - Go Long!

26 May 2008
China’s Industrialisation: Resources Strong - Go Long!

The single-most resounding theme for the Australian market has been the industrialisation of the world's emerging economies, particularly India and China, which has resulted in unsurpassed demand for Australia's iron ore, coking coal and other commodities. Increasing demand combined with supply constraints have led to record commodity prices of which the major beneficiaries are Australia's resource majors. The rally in resources has been so forceful that the S&P/ASX 300 Resources Index has overtaken the S&P/ASX 300 Financials Index as the largest component of the Australian market for the first time since the late 80's. BHP Billiton's market capitalisation now outweighs that of Australia's 7 largest banks with the resources boom set to continue. In short, China and India want what Australia has.

The Chinese economy has decoupled itself from the US with over 90% of demand being internally driven. Infrastructure demand is approximately double GDP growth of 10% with urbanisation leading to the government's 5 year plan of spending $USD120b per year on infrastructure improvements in the way of 1,000 new water treatment plants, 45,000km worth of railways, another 97 airports and huge growth in car ownership/manufacturing. A massive appetite for aluminium, copper and steel has resulted and efforts to rebuild Chinese Infrastructure following the earthquake will be highly metal/steel-intensive.

Beijing surpassed Tokyo as Australia's largest commerce partner in 2007 with two-way trade of $50b which can be attributed largely to our iron ore and coking coal deals.

  • Iron-ore exports to China increasing by 28% in April and prices are expected to increase by 85% inclusive of freight rate premiums.
  • Coking coal prices have tripled to $300 per tonne. In the coal space, Macquarie Research (MRE) recommends Felix Resources, Centennial Coal and Straits Resources in that order. India's, Arcelor Mittal, emerged as the new stakeholder in Macarthur Coal, buying the 15% stake for $450m amid wide belief the company will make a move on the company.
  • Supply constraints have resulted in record crude oil prices with MRE’s picks in the sector being Woodside Petroleum, Origin Energy, Oil Search and Santos. It is anticipated that China’s pollution problem will lead to higher demand for greener energy such as Liquefied Natural Gas and Uranium. It is expected that China's demand for LNG will soar to 24m tonnes by 2012.
  • As a side-effect of the resources boom, mining services companies such as Worley Parsons and Boart Longyear are well-positioned to reap the benefits.

The resource majors experienced a short-term correction (down ~5%) last week after some profit-taking emerged. However, despite weaker commodity prices last week, further consolidation in the resource space is anticipated. Merger and acquisition transactions with China in 2008 have totalled $2.1b thus far, compared to $1.8b for the whole of 2007. The moral of the story is: go long resources as the emerging economies want what Australia has.