China's metals market retreat tempts bears

WITH evidence of real recovery from the global economic meltdown still patchy at best, the mining sector – traditionally a “late cyclical” play – should by rights still be in its end-2008 trough. Yet 2009 has seen an amazing resurgence in the sector, borne up on an industrial commodity price recovery defying belief. Bellwether base metal copper has more than doubled since January, and the FTSE 350 mining index is meanwhile up 150 per cent year-to-date. Is this sustainable?

Underlying the 2009 mining bull market has been the mother of all Chinese restocking drives. The workshop of the world traditionally builds fresh metal inventories following the Lunar New Year festival, which ends in February or early March. This year, however, the stock build ran far longer than foreseen, and continued even as its own momentum bid up prices far beyond levels that seemed justified initially. Was this precautionary working capital management, given China’s massive stimulus spend on domestic public infrastructure? Perhaps – but even as Chinese stocks ballooned and prices soared, it is clear much of this material is not needed any time soon.

In copper, for example, market-watchers report a “shadow” inventory held away from and far exceeding already-elevated official warehouse stocks. The red metal has been piled up by all and sundry, including many who have no real business with copper. This is speculative hoarding on a grand scale. Those close to the action now declare this phase is over. BHP Billiton chief exec Marius Kloppers said last week that Chinese restocking was ending. And he also warned that recovery in OECD industrial demand, which optimists see emerging in time to fill the demand gap left as the Chinese withdraw, is “slow to start” and “lethargic”.

Where does this leave the mining sector? Enthusiasts point to there being only two to three months before the end of the next Chinese New Year festival. Yet with China still stuffed from a 2009 stock build, should we really expect a repeat of the previous performance in 2010? Surely the existing Great Wall of domestic stocks will have to be partly dismantled before imports are again sought in earnest. If developed world demand fails to kick into gear and the 2010 post-February stock build in China disappoints, it could be a long way down for FTSE mining shares – particularly as much of their gains have come on thin volumes, providing little resistance in case of reversal.

Will the miners enjoy a Happy Lunar New Year? Or will Chinese indigestion with existing stocks dent the sector even before then, as it seems copper is now starting to reverse out of the country and back into the international market? Pessimists can put their money where their doubt is through a slew of CFDs referencing the FTSE 350 mining sector, from well-known providers such as CMC Markers and City Index.