CITY FOCUS: How long can China keep the miners shining?

By SAM FLEMING FOR MAILONLINE
Updated: 03:21 EST, 29 May 2009

Grab your pick-axe and hard hat - the miners are on the move again. The FTSE mining index has rallied 50 per cent in the past three months, with shares including Rio Tinto, Anglo American, Xstrata and Kazakhmys recording glowing gains. 

Commodity prices have rebounded, with the price of copper up 65 per cent from its one-year low.

Ship-spotters are reporting long queues of vessels waiting to disgorge cargoes at Chinese ports. The People's Republic imported record quantities of base metals in April.

Booming: Many of China's ports are still stacked full of cargo

Indeed, aluminium imports last month equalled the entire figure for 2008. Analysts at Standard Chartered describe the scale of the surge as 'shocking'.

This burst of activity has wrong-footed many investors. The first quarter of 2009 saw an unprecedented crash in global trade.

Major economies are spiralling into their deepest slumps for over half a century, with the U.S. shedding half a million jobs a month. Why is the metals sector regaining its shine? 

Oddly enough, one answer lies in the crash in global industrial output at the end of last year. 

The manufacturing cycle normally churns out huge amounts of scrap metal, as old cars, fridges and consumer electronics kit are replaced.

But with factories shutting down across the world, there has been a dearth of metal for recycling.

Analysts at Macquarie estimate scrap copper imports into China halved in the first two months of 2009.

This led to a jump in demand for freshly produced metal, boosting prices and catching miners off guard. 

But the more important force at work is the Chinese government itself. Beijing's £364billion fiscal stimulus includes initiatives aimed at sustaining industrial demand, such as programmes renewing electricity grids and building lowcost housing.

China's State Reserve Bureau has been busily building up its stockpiles of copper, aluminium, zinc, and nickel.

This is partly to cushion the economy against a possible future spike in prices. But analyst Jonathan Guy of Investec said it is also motivated by politics.

Put simply, the last thing Beijing wants to see is legions of jobless workers from shuttered mines, steel mills and aluminium smelters.

'The big fear of the Chinese government is unemployment, which leads to social unrest, so they are buying metals just to maintain employment,' he said. 

Accordingly, the state has been maintaining an artificial floor under prices by buying metals on the market.

That clearly cannot go on forever. At some point soon we will need to see a sustained rebound in industrial demand, both in China and elsewhere around the world, if metal valuations are to be sustained.

Some analysts believe we will come to a crunch point soon - perhaps as early as this summer.

'There is a risk things have got ahead of themselves, and that may manifest itself in the third quarter of the year,' said commodities strategist David Barclay of Standard Chartered.

Aluminium is a particular worry. Inventories have grown at an unprecedented rate in recent months, reaching 4million tonnes - a level described by Citigroup as 'staggering'.

If there are green shoots for the mining industry, it argues, they are appearing 'at the bottom of a well'.

On top of this, the role of financial speculators in metals markets remains cloudy.
Traders have maintained their interest, and there is recent evidence of a pickup in investment flows into commodities, helping push prices higher. 

All this suggests investors should be wary of false dawns. Firms with heavy aluminium exposure, like Rio Tinto (up 19p at 2756p), look particularly vulnerable, as do 'racier' shares like Xstrata (down 11½p at 649½p), said Investec's Guy.

The captains of the mining industry are certainly not counting their canaries. Marius Kloppers, chief executive of BHP Billiton (down 3p at 1431p), told a conference this week that he is not expecting a 'sharp rebound'.

'Our view is that overall world economic recovery will be slow and protracted,' he added. 

'As much as I would like to be able to say that with 2008 behind us, so too are the economic challenges, unfortunately that is not the case.'