At a time when it seemed nearly impossible for mining companies of any size and shape to attract financing of any kind it took the market by surprise when Chinalco announced that it was injecting $19.5 billion into mining powerhouse Rio Tinto. Little did we know, back on February 12th, that the financing would come from the Bank of China, a troubling development to say the least.
While it may sound hypocritical or me to criticize the Chinese for using sovereign funds to effect a large scale corporate acquisition from my perch atop Mount Govermore here in the United States, it does not excuse the fact that artificially low interest rates secured by Chinese manufacturers in recent years have contributed greatly to the global economic downturn. After all, if the Chinese government had not given loans to so many business owners at interest rates which would have made the Japanese blush, many of the problems of global overcapacity might have been mitigated. While it is easy to blame the U.S. for all of the world’s problems and laud the productivity of the Chinese, let us not forget the distortions they imparted upon the world’s economy over the past decade.
As a westerner, the large scale deployment of Chinese funds to take advantage of the misfortunes of Russian, Australian, and Canadian resource corporations selling at fire sale prices will have profound ramifications. Not only will Chinese policymakers have influence over corporate decision making in these deals, but they will have further leverage in resource markets as state-owned resource firms such as Chinalco grow bigger. In short, the long arm of the Chinese government is expanding, and rapidly.
From the perspective of the Chinese, these deals make perfect sense. No country on earth has the enviable combination of vast reserves and lending capacity like the Chinese. By being a buyer in the purest buyer’s market in the history of the world’s economy, China stands to gain tremendous economic clout. By securing resources from increasingly distressed mining companies, the Chinese are essentially cutting costs on their massive infrastructure ahead of what will ultimately significant upside pressure on prices due to inflationary forces stemming from global government stimulus efforts. Combine this with China’s recent history of forsaking profits for the benefit of commercial profits through product dumping and sub-market financing rates, and you have the ingredients for a swift Chinese reemergence.
So while the Chinese benefit in the near term from a communist structure which allows them to broker deals which the private sector alone would not be able to accomplish, the U.S. finds itself mired in a transitory phase of nationalization and socialist spending. For westerners the result will be painful. For the Chinese the benefits are endless.
For investors, the path is not quite as clear but equally important. The obvious conclusion for us is to preempt the rebound in resource companies by looking at those resource producers whose debt burdens have begun to cripple their market value and whose asset base is extensive. The strategy is not without its risks, however, as owning names like Xstrata and Teck Cominco, two companies who fit this description, is a bet on recapitalization, something which has been hard to come by if you are not in bed with the likes of the Bank of China.