Chasing Rare Earths, Foreign Companies Expand in China
Comment of the Day

August 25 2011

Commentary by David Fuller

Chasing Rare Earths, Foreign Companies Expand in China

This is an interesting article by Keith Bradsher for The New York Times. Here is the opening:
CHANGSHU, China - China has long used access to its giant customer base and cheap labor as bargaining chips to persuade foreign companies to open factories within its borders.

Now, corporate executives say, it is using its near monopoly on certain minerals - in particular, scarce metals vital to products like hybrid cars, cellphones and energy-efficient light bulbs - to make it difficult for foreign manufacturers of high-tech materials to build or expand factories anywhere except China. Companies that continue making their products outside the country must contend with tighter supplies and much higher prices for the materials because of steep taxes and other export controls imposed by China over the last two years.

Companies like Showa Denko and Santoku of Japan and Intematix of the United States are adding factory capacity in China this year instead of elsewhere because they need access to the scarce metals, known as rare earths.

"We saw the writing on the wall - we simply bought the equipment and ramped up in China to begin with," said Mike Pugh, director of worldwide operations for Intematix, who said the company would have preferred to build its new factory near its Fremont, Calif., headquarters.

While seemingly obscure, China's policy on rare earths appears to be directed by Prime Minister Wen Jiabao himself, according to Chinese officials and documents. Mr. Wen, a geologist who studied rare earths at graduate school in Beijing in the 1960s, has led at least two in-depth reviews of rare earths this year at the State Council, China's cabinet. During a visit to Europe last autumn, he said that little happened on rare earth policy without him.

China's tactics on rare earths probably violate global trade rules, according to governments and business groups around the world.

A panel of the World Trade Organization, the main arbiter of international trade disputes, found last month that China had broken the rules when it used virtually identical tactics to restrict access to other important industrial minerals. China's commerce ministry announced on Wednesday that it would appeal the ruling.

No formal case has yet been brought concerning rare earths because officials from affected countries are waiting to see the final resolution of the other case, which has already lasted more than two years.

David Fuller's view China's tactics on rare earths are not in the spirit of global trade rules but they are certainly effective. Foreign (non Chinese) companies requiring rare earths metals will not wish to engage in lengthy law suits, which might restrict access even further. While China still has a monopoly on these strategic materials, it makes far more sense to open factories there.

Like it or not, this is yet another example of China's superior tactics in the globalisation game.

When might this be reflected by China's stock market?

Not before the government reverses its monetary policy from restrictive to accommodative, in my opinion. This is unlikely to take place before China's inflation moderates, for housing to staple commodities such as pork, grains and crude oil. That may require a somewhat weaker global economy.

Following this month's sharp fall in line with global stock markets, the Hang Seng China Enterprises (H-Shares Index (monthly, weekly & daily) has steadied above the psychological 10,000 level. However, the pattern shows insufficient support building to sustain more than a technical rally at present and we cannot be sure that a sustainable low has been reached.

Nevertheless, valuations in China's stock market have continued to improve. HSCEI currently trades at an historic PER of 9 and yields just over 3%. These long-term charts of the HSCEI's PER and Yield indicate that it is returning to levels where long-term investors may wish to accumulate on easing for the eventual recovery potential. Another strategy would be to wait until we do see evidence of a loosening in China's monetary policy before buying.

(See also Eoin's comments on China below.)

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