Xstrata’s bid for Gloucester brings us back to the global attraction Australian resource reserves have for investors, not to mention massive mining firms. Australian assets remain attractive to foreign buyers, especially real assets, which are both tangible and scarce (unlike, say, a mortgage-backed bond, which is intangible, yet abundant.)
But as the big fish in the resource sector begin eating the little fish, we wonder if it’s time to go fishing in a different sea altogether, at least from a growth perspective. For example, both BHP and Santos reported record production, respectively. BHP cranked out record amounts of copper, alumina, nickel, natural gas, and manganese ore. If it could actually mine more uranium, it probably would have cranked out more of that stuff too.
We know that production is running full-tilt to keep up with Chinese demand, which is still resource intensive. But we also know that costs are rising for major miners. Labor is scarce. Energy inputs keep going up in price. Rising costs will begin to eat into margins.
We also know that base metals price are within striking distance of their ceiling. When prices are too high, people stop buying. This is called “demand destruction” and it’s basically what happened last year in China when base metals prices went through the roof. It killed demand.
So the major resource stocks, though they have demand growth and scarcity on their side, have rising costs and prices working against them. When we put all that together, it turns us Japanese.
And here is your strategy insight of the week, dear reader. The first phase of China’s massive economic growth was industrial. That is another way of saying it was resource intensive, especially the base metals that literally make up the bones and scaffolding of China’s new manufacturing economy. But if an economy evolves like a life, what comes next for China?
There will still be plenty of resource-intensive growth in China. But investment in fixed assets, either naturally or through government curtailment, is going to decline as a percentage of GDP, especially as GDP grows. So if it’s not new skyscrapers, bridges and goods-producing factories, what will be the primary driver of China’s growth?
Our first answer is consumer goods. What do people do when they have a little money? They spend it. True, some people save it. But we have no reason to believe newly-affluent Chinese consumers will be less materialist than deeply-indebted Americans. Do you know what this means?
It means that up to know, the China story has been a resource story. And the resource story is largely an Australian story. The relationship between Chinese growth and Australian resources will remain strong. But the next phase of Chinese growth is in consumer goods, not raw materials. And that means investors will need to look to other sectors and other markets for the most profitable way to participate in China’s continued growth.
A casual analysis suggest to us that Korean and Japanese electronics firms might be a good bet. Our colleague Marc Faber made this observation in his last issue of The Gloom, Boom, and Doom report, “Investors frequently have a negative view of Japan because they perceive the economy to be rather weak, its ageing population to be a headwind to growth, and because they think that Japan lacks innovation. But as Sharmila Whelan of CLSA showed in a recent report entitled “Power without People”, Japan has been growing rapidly since the 1950s despite very little population growth.”
“Concerning Japan’s lack of innovation, Whelan notes that, “one needs to remember that in the 1970s and 1980s Japan was setting the global standards for operational effectiveness. High quality and low cost, just-in-time manufacturing, continuous improvement and rapid cycle time became hallmark features of Japan Inc. Whelan has found that, compared to its peers, Japan’s information and communication technology (ICT) sector is doing surprisingly well: “Of the top 49 global ICT companies (measured in terms of revenue earned) 17 are American. Japan follows not too far behind with 13 companies.
“By contrast Germany, France and UK each has only two world class ICT companies and Europe in aggregate has 11. Japan’s top 13 global ICT companies are way ahead of their European counterparts in terms of aggregate revenues earned, both in absolute terms and as a share of nominal GDP. On the latter measure they are ahead of the US as well.”
Whelan also shows that, in terms of market capitalisation, America’s top ICT companies are larger, but that Japanese companies are not far behind. Also Japanese ICT companies have a heavy weight as a percentage of domestic market capitalisation, and “there are more people working for Japan’s top ICT firms both in absolute terms and as a share of total employment than in the US and Europe. The numbers for Japan are likely to be higher once small and medium-sized ICT firms are included.
Japanese and Korean firms can help build out Chinese information technology networks (the same way BHP has helped build the skyline in Pudong). And on the retail end, the market for consumer electronics goods in China…well like everything else in the country, it’s going to be huge. More on this in the coming months. It’s a big theme. And we have a chance to participate in it early, before the hot money picks it up.
Markets and Money
What do you think about the resources boom and what could be next for Asia? Post a comment below.