Chinalco failure on Rio could be China's fault

IF Chinalco fails in its $27 billion bid for a large chunk of Rio Tinto, the Chinese Government could be to blame. Not because of any direct political machinations but due to a very smart Chinese reaction to the global financial crisis. China has been quietly stockpiling large amounts of copper recently, leading to an almost 50 per cent rise in the price of the "new gold". That is a very unusual price rise coming at a time when manufactured exports from China and other Asian countries have been falling sharply. It is a lot more logical, though, when you factor in China's alternative forms of investment for its massive $2.7 trillion of foreign currency reserves. By buying a record 329,000 tonnes of copper in February and following that up with 375,000 tonnes in March, China is signalling that it will spend some of its reserves stockpiling metals. That is a direct response to the US Government's apparent strategy of once again "sucker punching" foreign investors by getting them to buy up bonds and then deflating the bond's real value over time by printing money. By buying easily stored, hard assets, such as copper, China manages to increase its export competitiveness by holding down its currency and at the same time hedge against raw material supply disruptions. There is also absolutely no danger that the copper and other stockpiled metals will not be used, which could otherwise lead to an overhang in the market and price falls. With the growth in electric cars, motorcycles and hybrids, China will be able to add value and export a lot of that copper. THE country is also in the process of being wired up for electricity, which will keep domestic copper usage high for many years to come. Add in a near trillion dollar stimulus plan within China and the actions of China's State Reserves Bureau in starting to stockpile copper, aluminium, zinc, nickel and rare metals come into sharp focus. China's actions probably even make good sense on an investment level. While the GFC will cut industrial demand for metals for several years, mining most metals is getting harder and more expensive as easy to access deposits are exhausted. So in the long term, the only sensible direction for mineral prices in real terms is up, particularly when world demand and growth eventually recovers. Which makes the idea of building up reasonable stockpiles while prices are cheap as a hedge against US inflation and supply disruptions quite a sound one. We probably shouldn't have been too surprised by the Chinese move given last month's comments by central bank governor Zhou Xiaochuan, who called for a world currency based on commodities similar to the Bancor idea floated by John Maynard Keynes at the Bretton Woods conference in 1944. Zhou's comments that such a currency would prevent the sort of credit based excess that is troubling the world economy now should have been a clue to the direction Chinese thinking was taking. By stockpiling minerals, China is effectively buying a commodity currency which can be productively spent down the track. All of which is extremely bad news for the US, which faces the prospect of finding alternative countries with trade surpluses to buy bonds to fund its ballooning budget and trade deficits. And potentially great news for Australia, which has massive natural unmined stockpiles of most minerals and is already enjoying the positive price trend for our mineral exports. The prices we are getting for exports may not be equal to those at the top of the commodity boom but they are much better than would have been the case if China had cut its raw materials imports to match its fast waning exports. C HINALCO may not be too excited by the trend though, with its deal to buy 18 per cent of Rio Tinto and direct stakes in a swag of Rio mines looking less attractive by the day. When credit markets had turned to permafrost and Rio Tinto's share price plunged to less than $30, the Chinalco deal looked like one of the few alternatives available. Raising enough money to pay off a meaningful chunk of its massive Alcan debt through equity markets seemed close to impossible and the potential prices for asset sales were not encouraging. Things are very different now. Credit markets are now closer to a slushie -- cold but not impossible -- as Rio showed this week by raising $US3.5 billion ($A4.83 billion) on bond markets. And the share market is even healthier, with Rio's close yesterday of $58.05 showing that a rights issue to all Rio shareholders including Chinalco would comfortably relieve the balance sheet pressures of the ill-advised debt-financed $US38 billion Alcan purchase. T HERE are a couple of options as to how Chinalco could end up all dressed up at the altar only to be jilted by the Rio Tinto groom that worked so hard to woo it. Wayne Swan and the Foreign Investment Review Board could "do a Costello" and block or pare back the bid on national interest grounds. Or Rio Tinto shareholders could simply give the deal the thumbs down when they get to vote on it in Australia and London. Either way, some of the current board and management could find themselves going the way of the deal if that happens.