China is a dominant player in global trade, but it’s not the superpower in the commodities market it appears to be. After the maritime dispute between China and Japan in the East China Sea, China may have played some cards in global trade to persuade Japan to release the captain of the fishing vessel sailing in disputed waters.
Speculation emerged last week that China had halted or restricted shipments of rare-earth resources to Japan.
And earlier this week, China hiked inspections for Japanese exports and imports and raised the anti-dumping duty on U.S. chicken products.
“China has discovered that being an important customer gives one some leverage,” said Ned Schmidt, editor of the Agri-Food Value View Report, because when it comes to commodity imports, “China has the check book. No other market can replace Chinese demand for commodities.”
So far, it appears as if China has managed to successfully use that influence. The Japanese gave in to political pressure, releasing the Chinese boat captain last week.
“China is becoming much better at playing the global political game,” said Schmidt, who’s also editor of the Value View Gold Report. “Restrictions on commodity imports and exports will be rifle shots, not a shotgun approach.”
Even so, what appears to be China’s strength may actually be its weakness.
“China is a net commodity importer, not a net commodity exporter,” said Martin Hennecke, an associate director at Tyche Group Ltd. in Hong Kong.
That means “other countries have more power over China in denying China the needed commodity imports, than China would have over the other countries,” he said.
Ending up the victim
So if China used its pull in the commodities markets, as it may have already done, it could ultimately end up a victim of its own actions.
In that sense, the nation’s not a commodity superpower because it cannot afford to exercise control over the market.
“I don’t think that China can play any commodity cards,” said William Gamble, president of Emerging Market Strategies. “They import commodities.”
True, “just about every commodity I can think of is affected in some way by demand from China,” he said, noting that China is a net importer of oil, iron ore, cotton, corn, wheat, soybeans, sugar — and “just about everything else.”
It’s strength in the global trading markets, therefore, lies in the fact that it consumes so much of the world’s resources.
“China has become such a huge consumer of so many resources that the Chinese can certainly move markets by not buying commodities, increasing their purchases or by flooding the market with finished products,” said Malcolm Gissen, co-manager of the Encompass Fund
But that would be to its disadvantage.
If China cuts off demand by limiting imports, “it just hurts their economy by driving up prices, which increases inflation,” Gamble said, and “cutting off demand helps everyone else.”
“Fortunately, the Chinese are under pressure to keep people employed, to keep their economy growing, and to continue importing many of the raw materials they need,” said Gissen.
Influential exports
Still, China has a few commodity exports it can use to flex its muscles, if it chooses to.
Rare-earth resources are definitely a stand-out among those, though maybe not as powerful a retaliatory tool as some might think.
China dominates production of the world’s rare earths, which are used in everything from automobiles and computer monitors to pharmaceuticals.
“In rare earths, China is the big stick,” Schmidt said, pointing out that no substitutes exist for these resources.
That’s what makes withholding rare earths such a persuasive tool.
But rare earths are only valuable when they’re used in manufacturing as part of a long supply chain, said Gamble.
“Some of the rare earths used in manufacturing some components either originate in China or return to China for further processing,” he said. “If China cuts off the supply, it also disrupts the supply chain and hurts itself.”
The nation also exports a number of metals and would affect a number of economies around the world if it stopped exporting refined copper, aluminum, sheet metal and silicon metal, Gissen said. Even so, “there are other sources for these metals, and the Chinese do not control any other metal to the extent they control [rare-earth elements].”
So maybe rocking the commodities boat isn’t in China’s best interest.
Hidden strength
But China has other options when it comes to making a show of power.
“China has a more important tool than commodity exports,” said Schmidt. “China’s most important commodity is money, and ultimately everyone wants to do business with them.”
The U.S. has become dependent not only on “Wal-Mart (NYSE:WMT) China-made goods, but also on credit from China (Treasury purchases),” said Hennecke. “If China sold its Treasury holdings, it could cause the collapse of the U.S. financial system anytime, which would be much more devastating than not exporting a few commodities.”
At the end of the day, however, “it’s not in China’s interest to harm either Japan or the United States, as China too aims to develop a healthy trade with the rest of the world, and to grow its economy in a stable world,” he said.
Besides, “trade is China’s lifeblood,” said Sean Brodrick, a natural-resources analyst at UncommonWisdomDaily.com, who doesn’t believe China wants to hurt trade with Japan or the U.S. “If anything, I think China will want to expand trade with the U.S. to make us more dependent on them.”
Focused investing
With that in mind, Hennecke said Tyche Group is optimistic of China’s continued growth and invests in the commodities that China imports.
“Due to the risk of a short-term global financial crisis return ... we [are] overweight the precious metals and agricultural sectors, which in our view are less at risk of a correction, as they are not very dependent on global economic growth,” he said.
Gissen points out that China’s growing consumer society has created demand for every kind of raw material, as well as food.
“In the case of rare-earth elements, where China controls over 90% of the mineral and has growing demand of their own, we thought it was smart for us to invest three years ago,” he said.
Avalon Rare Metals Inc., which has significant quantities of rare earths, especially the more valuable heavy rare earths, is among the top 25 holdings in the mutual fund Gissen co-manages. The Encompass Fund posted a 137% return in 2009.
“Investors should buy companies that control [rare-earth elements], are in production or are moving toward production, have a great management, and control more of the heavy rare earths, as they will demand a far greater price than the light rare earths,” said Gissen.
Source: MarketWatch
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