One commodity that will survive a hard landing in China
Matthew Partridge Feb 27, 2012
Between 1999 and 2008, commodity prices soared. Easy money was partly to blame.
But the main driver of the boom was China’s growing demand for raw materials. This came at a time when supplies were tight, as miners had slashed investment during the long commodity bear market of the 1980s and 1990s.
We advised our readers to take full advantage of the boom during the good times. But now, this process has now gone into reverse. Fears of a 'hard landing' in China have pushed the CRB-Reuters commodities index down by over 30% over the past year.
If China’s economic growth slows by more than most analysts expect (and we believe it will), then the country will need fewer raw materials. At the same time, having geared up during the boom times, miners will find it hard to cut supply.
That could be bad news for most industrial commodities. But there are exceptions. And one of them is the somewhat obscure metal, tungsten…
China wants to keep its tungsten for itself
Tungsten is a very tough metal. Its hardness means it is used a great deal in mining, oil drilling, metals and electronics. Most importantly, it’s vital to the defence industry, as a key element of everything from bullets to missiles.
And here’s where it gets interesting. In recent years, China has been expanding its armed forces. This is something that will continue, almost regardless of how hard a landing the country experiences. China’s latest plan is to double spending by 2015, with a focus on updating its military hardware.
That means more weaponry – and more tungsten.
Because of this, China has been buying up raw supplies of the metal and restricting exports. That matters: 60% of the world’s reserves and 83% of global production comes from China, so the restrictions have had a big impact.
The price of tungsten rose by 35% last year, and consultancy Roskill thinks prices could rise by another 15-20%. Indeed, Mexico, the US and the European Union all took China to court over this export ban – yet despite losing the case, China has continued with the policy.
This is great news for tungsten producers outside China
Tungsten is only traded in spot form, so you can’t buy it directly. However, as US financial paper Barron’s notes, you can buy shares in two of the key non-Chinese tungsten producers, both of which are listed in Canada. With competition from China now limited, they should be perfectly placed to satisfy demand and take advantage of rising prices.
North American Tungsten (CVE: NTC) has 113 mineral claims and 36 mining leases in Canada, including a mine in Cantung and a deposit in Mactung. This makes it the largest tungsten producer in the West. It also owns a stake in a processing company, which enables it to capture a greater part of the supply chain.
Another interesting firm is Malaga (TSX: MLG), which operates a tungsten mine in Peru. Recently it negotiated a long-term contract with a major tungsten user, which should secure its financial future.
So assuming that you’re happy to take a punt on a highly risky, small mining stock – which horse should you back?
Here’s why we’d bet on Malaga
Although both miners should benefit from higher prices, there are some serious concerns over North American Tungsten. The company has faced both operational and financial difficulties. It was forced to shut down its mine from 2003 to 2005, and again in 2009. It also got into trouble with its lenders in the same year.
Even with higher prices the company has found it hard to turn a profit, making a loss of $16.8m last year. The chief executive admits that the location and facilities make it “a relatively high-cost tungsten concentrate producer”.
Even if tungsten prices remain high, North American needs to raise more money for equipment, and to keep its bank onside to survive. Mactung will remain a pipe dream unless it can get a large amount of financing.
In the end, the miner’s best hope may be to find a larger company to partner with – or be taken over by. Although no such company has yet emerged, continued high prices may tempt one of the big names to make a bid.
So rather than cross your fingers and hope for a bid, you could look at
Malaga. This miner managed to make a profit last year. Its current low price puts it on a price/earnings ratio of four. It has been smart enough to work with larger companies, and has also agreed a joint venture with a Swiss firm to deliver a new power plant that should further improve its cost competitiveness.
Given that this is a risky bet anyway – a collapse in tungsten prices would hammer both stocks, and there are the usual political and regulatory risks to consider – we’d rather opt for Malaga in this case.
• This article is taken from the free investment email Money Morning.
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