2015-03-14

A Micro Example of China's Macro Implosion

Steelmaker Powerless as Iron Mines Sink Abroad
A Chinese steelmaker digging for its own iron to save money may have hit a rock by investing heavily in overseas mines.

Wuhan Iron & Steel (Group) Corp. (WISCO), a state-owned and Shanghai-listed conglomerate that's also one of China's largest steel producers, is grappling with the consequences of financial trouble at Brazilian and Canadian mines in which it invested.

WISCO controlled up to 20 percent of MMX Mineracao & Metalicos SA, which owns iron ore mines in Brazil and Chile but recently went bankrupt. It's also a business partner with U.S. mining company Cliffs Natural Resources Inc., operator of the Bloom Lake mine in Quebec, which in January suspended production.
China has made these types of pro-cyclical or to channel Pettis, volatility enhancing investments, all across the economy. All of the resource bets in Africa, across Latin America, North America, Asia and Australia were all predicated on ever growing demand from China. When the Chinese themselves began to rebalance, all of these investments collapsed in value and are still in the process of collapsing. The result is extreme volatility as the company's main operations contract and their outside investments fail simultaneously. They have built a great investment for traders and volatility junkies because their balance sheet is the exact opposite of stable.
The decline in ore prices was totally unexpected, Li said, so WISCO's management cannot be faulted for pursuing its overseas investment plan. The same "going out" strategy centered on buying foreign assets and doing business abroad has been followed in recent years by a variety of Chinese state-owned companies, he said.
This is not the Spanish Inquisition, but a cyclical commodity market. How many other price declines in China are totally unexpected? Oil, real estate, farmland, gold, silver, euros, Australian homes, the renminbi......

At least for these steelmakers, no bailout of failed investments is coming:
The government has seen overseas investments by WISCO and other domestic steelmakers as market decisions, and that all of these activities should follow rules of the market, said a government official.
WISCO is still trying to bail itself out though, a move probably doomed to failure unless the renminbi price of iron ore rises, which would require yuan depreciation.
Unless ore prices rebound, WISCO will not benefit as expected from these mine investments. On January 9, in a move highlighting hopes for a turnaround, the company formed a resources company to take charge of managing overseas mines. But in the short run, the steelmaker finds itself powerless to rescue these foreign investments.

Putting aside the timing of WISCO's investments, if an individual company wants to build a "volatility machine," it will be an attractive investment during the upswing in the cycle and a great short during the downswing, but a well managed company without excessive debt could manage it. If on the other hand, the entire economy's balance sheet bears a resemblance to WISCO, there will be a depression.

Related: China's Volatility Machine

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