Inauspicious omens for our fund on Olympic opening day. Our initial RMB10,000 investment is now hovering around the 7,000 mark, tethered as it is to the sinking stone of Anhui Conch and the anemic Guangji Pharmaceutical. Anhui has now lost nearly half its value since we scooped it up in early June, and riboflavin producer Guangji is down 25% since we bought it a couple of weeks back.

ICBC, our third stock, continues to stick around at about the level we bought in, which is not bad considering that the Shanghai Composite Index is once again nearing the 17-month low it hit back in mid July. These are grim times, but who’s watching the markets today anyway? All eyes are on Beijing’s National Stadium for tonight at least. Maybe next week we’ll gain the fortitude to make some moves that take us in a positive direction.

It isn’t surprising that China’s first successful hostile takeover bid for an overseas company concerns commodities. Neither is it surprising that Sinosteel, the country’s second-largest importer of iron ore, is involved.

China’s voracious appetite for iron ore and the M&A ambitions this has nurtured among steelmakers keen to secure supplies in a climate of rising commodity prices was the subject of a report in the July issue of China Economic Review. The people we spoke to for the report - all of whom are directly involved in the industry or advise on deals relating to it - agreed that Sinosteel was one of, if not the, most aggressive Chinese player.

Chinese interest in Australia’s high-quality iron ore hit the headlines in February with Chinalco’s investment in Rio Tinto. Buying into one of the big three global mining firms was audacious. But Chinalco’s approach - bringing American steelmaker Alcoa on board as if to stress that this was a commercial rather than a state-driven transaction - displayed a deal-making savvy that had been notably absent in previous attempts by Chinese firms to participate in high-profile overseas investments.

Sinosteel’s aggressive takeover of Midwest has taken things to a new level - and it probably won’t be the last such deal.

“Working on China-related deals two or three years ago, I once gave a presentation to an interest group in which I said Chinese investors did not yet have the appetite for hostile takeovers,” a Chinese lawyer working for an international law firm told China Economic Review. “But I am sure we will see a lot of more of these over the coming months and years. Chinese investors are increasingly sophisticated.”

The lawyer said he was currently working on two commodities-related investments by Chinese firms in Australia. He added that one of these deals could well end with an aggressive takeover bid.

The million-dollar question is: Will Australia reach a point at which it becomes uncomfortable with the level of Chinese investment?

Chinese steelmaker Shougang found itself on the wrong side of the regulator when one of its subsidiaries tried to buy a stake in Mount Gibson Iron. There were concerns that, should the deal go through, Shougang would hold too much sway over Mount Gibson because the Chinese firm held a significant stake in a company that was already a Mount Gibson shareholder. More recently, Shougang’s bid for a stake in Australian iron-ore miner Property Resources was also rejected.

However, the Australian government has gone to great lengths to say that the country still welcomes Chinese investment. According to Finance Minister Lindsay Tanner, Australia’s assessment of foreign bids is “agnostic” when it comes to the nationality of investors.

It remains to be seen whether or not public opinion - and, as a result, political sentiment - can hold firm to these principles.

According to Paul Atherley, managing director of gold mining company Leyshon Resources, Heilongjiang province in northeastern China has so far produced 20 million ounces of gold - and most of that has been picked up off the ground.

Atherley was speaking at the Mining & Metals 2008 conference in Hong Kong yesterday, an event which also featured a couple of the other foreign-invested stars of China’s burgeoning gold industry, Jinshan and Sino Gold. Lest we forget, China became the world’s largest gold producing country in 2007, ending South Africa’s 102-year reign at the summit.

Heilongjiang is sitting on a rich seam of gold (Yunnan is the other key gold-producing area) but the absence of proper drilling expertise means it has gone largely untouched, apart from the easy pickings sitting on or close to the surface. As a result, foreign operators are queuing up to get involved. Leyshon, Jinshan and Sino Gold have all been to the capital markets (AIM, Toronto and Australia/Hong Kong respectively) to raise funds and are now getting busy at the rock face with their joint venture partners.

China resources + foreign expertise = gangster bling.

Related

Reuters: June 10, Jinshan mulls HK IPO

Mining Weekly: China surpasses South Africa in gold output

Economist: Gold backgrounder

In August 2005, China Economic Review decided to invest RMB10,000 in the A-share market. This was the beginning of the Red Dragon Fund, which continues to appear in the magazine every month. During the course of its existence, the fund - currently under the care of fund manager Zhang Zheng - has tripled in value. (Rest assured, it is nothing more than an editorial exercise.)

Now our paymasters have allocated a new pool of cash to invest in the Shanghai market. The new RMB10,000 fund will be known as the Capitalist Roader Fund. Investment decisions will be made by the CER editorial team and our activities can be followed on this blog.

With that out of the way, we’re pleased to announce we’ve jumped right in with 100 shares of Anhui Conch Cement, China’s largest cement-maker, at RMB55.97 a share. We have been looking at solid, basic, infrastructure plays, since there’s still plenty of China to build. Conch was chosen partly thanks to a Citi Investment Research report by Thomas P. Wrigglesworth and Scarlett Y. Chen, which had good things to say about the cement-maker (albeit focusing on the company’s H-shares).

For starters, the report has a HK$87 target price for the stock with a Buy/Medium Risk rating. It ended trading yesterday at HK$66.85. Why so bullish? In the short term, there’s the massive reconstruction effort required as a result of the Sichuan earthquake.

It costs RMB80 to transport a ton of cement to Chongqing and another RMB100 per ton to get it to the quake area. Mr. Guo [Conch executive director] believes Conch could earn a decent margin given the high pricing in Sichuan. He said Conch would still make money even if the transportation cost amounted to RMB300 per ton.

According to Guo, the National Development and Reform Commission is likely to impose price controls on cement – he estimates that cement would cost RMB1,000 a ton if prices are allowed to rise freely. However, Guo believes the controls will be temporary, since cement-makers need to make money to continue to supplying their end product.

But this isn’t just an opportunistic quake play. The company was already moving its supply chain to the western provinces before the quake struck because prices in Sichuan were among the highest in the country, at RMB600 a ton.

The A-shares are trading at around a RMB10 discount to the H-shares, which is the opposite of what usually happens with dual-listed companies. The price-to-earnings ratio on the A-share is around 32, which is rather high for a cement company, but then Conch is in an unusually strong position to exploit China’s ongoing construction boom. As Wrigglesworth and Chen note, its production capacity is equal to the next-four biggest companies’ capacities combined. They also say that Conch hit a gross margin of 42% in 2003, which was the peak of the last industry cycle. By their estimates, the industry hit bottom last year and is on its way up to a 2011 peak.

Related
Reuters updates on Anhui Conch Cement’s H-shares and A-shares
Anhui Conch Cement’s website
Seeking Alpha: JP Morgan on infrastructure plays

We’re barely into the second quarter of 2008 and already China’s total outbound investment is closing in on the full-year total for 2007. Spending currently stands at US$24.52 billion (from 56 deals), up 1,000% on this point last year, according to Thomson Financial. The full-year figure for 2007 was US$29.84 billion (from 219 deals). In 2004, outbound investment came to just US$3.92 billion.

Obviously, this year’s numbers are skewed quite horrifically by Aluminum Corporation of China’s (Chinalco) US$14.28 billion investment in mining giant Rio Tinto (made through a subsidiary with a little help from Alcoa of the US). If there is anything to these rumors about Baoshan Iron & Steel seeking a 9% stake in BHP Billiton, the numbers would be skewed even more.

Aside from the focus on metals and mining (which is unsurprising given the current macro climate), recent deals are notable for their relative smoothness and sophistication. It is all a far cry from China National Offshore Oil Corp’s unsolicited and poorly prepared bid for US oil group Unocal in 2005.

Chinalco brought Alcoa on board as it helped preempt suggestions that this was another state-driven resource grab (which, to a certain extent, it was). This is a bona fide commercial move with a bone fide commercial partner, the could say. Structurally, this is not something that was conceived overnight.

As was highlighted in our cover story in March, Industrial and Commercial Bank of China’s purchase of a 20% stake in Standard Bank of South Africa for US$5.6 billion was three years in the making.

China Investment Corp, the country’s sovereign wealth fund, paid US$5 billion for a 9.9% stake in Morgan Stanley and US$3 billion for 10% of private equity firm Blackstone. Rather than create unrest within the US political community, these investments (and the subsequent losses incurred) have provoked domestic criticism of the government’s strategy. “They’re just stupid,” a Chinese dealmaker told me last month.

For more on Chinese outbound investment - with particular reference to acquisitions in the US and how one recent deal (Huawei’s bid for 3Com in alliance with Bain Capital) did go wrong - please see this special report from our April issue.

Highlights from the last week of China business news.

Defusing tensions
Taiwan elected economic pragmatist Ma Ying-jeou as its President in a landslide that saw Ma win over 58% of the vote. Ma, who favors bolstering economic ties with China, was widely seen as Beijing’s preferred candidate. He got right to the hard work of talking about mending fences with the mainland by hinting at a resumption of economic dialog, particularly in the areas of direct flights across the Straits, mainland access for Taiwanese banks, and tripling the number of Chinese tourists allowed to visit the island. The market responded with good cheer to the potential warming of relations, with tourism firms among the big gainers. But the US crashed the party by admitting it had accidentally delivered intercontinental ballistic missile fuses to Taiwan in 2006 in place of helicopter batteries (a simple enough mistake, really). China’s foreign ministry was not amused.

Movers, shakers, steelmakers
The metal industry was bubbling over with news this week. Rio Tinto’s CEO Tom Albanese said in Beijing that he wanted to work with Chinese firms to develop mining projects across the globe, in part to ease tensions over iron ore contracts with Chinese steelmakers. Albanese, however, had no plans to meet with any Chinese companies during his visit, notably Chinalco or Baosteel. Speaking of Baosteel, the leading steel-maker may face new competition from a merger by Laiwu Iron & Steel Group and Jinan Iron & Steel Group. The new company, Shandong Iron & Steel Group, will be the world’s seventh-largest steel producer. Meanwhile, Chinalco, which recently bought a share in Rio, announced it planned to spend between US$2.8 and 4.2 billion on acquisitions this year, with non-ferrous metals as a major focus. Xinjiang Non-Ferrous Metal Industry is also in talks to bring in state-owned firms as strategic investors and expand its rare metals unit.

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Highlights from the last week of China business news.

Hobnobbing in Bali and Beijing
Lots of high-powered meetings recently, with the attendant speculation about their outcomes. Probably the most enjoyable one to be at is in Bali, where 190 countries have sent delegates to hash out a plan - for two weeks - to replace the Kyoto Protocol, which expires in 2012. That meet started Monday, and, although details are still surprisingly thin on the ground, it appears that China will continue to reject imposed emissions targets. It will propose the creation of an international technology transfer fund - paid for by developed countries - that will help developing nations research and create their own clean technology. This works out very well for China, clearly. In the less salubrious environs of Beijing, another meeting of consequence ended this week, confirming the rumors that the top national leadership has decided to step up monetary tightening measures next year. The seasoned decoders of bureaucrat-speak at the Journal say officials now speak of a “tight” monetary policy for next year, instead of the “stable-to-tight” regime now in place. Next week, the US-China Strategic Economic Dialog happens for the last time this year. Hank Paulson flies in with Susan Schwab, product safety chief Mike Leavitt and others to talk about product safety and - surprise! - letting the yuan appreciate more quickly. Vice Premier Wu Yi must be glad she’s retiring in March.

Rio Tinto mines a rich vein of rumors
Will they or won’t they, steel executives wondered this week about a Chinese counter-bid for Rio Tinto. Last week, we wrote that China Investment Corp was rumored to be putting together a deal to buy into Rio, but that was quickly squashed by CIC and Rio executives. The sovereign wealth fund did say, after all, that it’s not confident enough to go raiding abroad yet, and that it would steer clear of sensitive industries. So the rumor mill promptly put new hearsay into circulation. For awhile, it seemed that Baosteel would spearhead a consortium of Chinese firms to snatch up Rio Tinto. A Baosteel executive told Economic Observer last week that his firm would only join a bid if the Chinese government wanted it to - hinting that a bid was possible, though not confirmed. Then the 21st Century Business Herald said Baosteel chairman Xu Lejiang confirmed that a bid was in the works. Shares of Rio Tinto jumped. Today, the official Shanghai Securities News quoted Xu denying the quote. “I did not say this. It is a fabrication of the media,” he said. Even with that seemingly definitive response to the matter, our guess is the rumor mill still has plenty of grist to keep it churning.

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Highlights from the last week of China business news.

Minesweepers
The world has three big mining companies, so when one of them tries to buy out another, serious consequences abound. Australia’s BHP Billiton has been trying to buy rival Rio Tinto, which caused alarm in China, because that would mean two companies (BHP and Companhia Vale do Rio Doce) controlling the supply of iron ore - not a situation a large iron ore buyer like China likes to find itself in. China Investment Corp, China’s new sovereign investment fund was rumored to be ready to swoop in with a counter-bid for Rio Tinto, reportedly rallying local steelmakers like Baosteel to put up a US$200 billion offer. The bid was quickly denied by both CIC and Rio Tinto on November 27. Nevertheless, a top Baosteel officer remarked to the Economic Observer after CIC’s denial that Baosteel would only join a Rio Tinto bid at the behest of the central government.

New ways to curb carbon?
Amid the chorus of calls for a stronger yuan this week from EU officials visiting Beijing, French President Nicolas Sarkozy added a threat about possible carbon tariffs for Chinese imports. He said he would defend the idea of a carbon compensation mechanism for imports to EU countries, before an important international meeting in Bali next week that will help decide a successor to the Kyoto Protocol. Earlier, the United Nations Development Program released a report that will set the agenda at the Bali summit that recommended cutting China and India some slack when it came to emissions limits. The report says that rich industrialized nations must bear the brunt of emissions caps. It also hinted that the cap-and-trade system implemented by the Kyoto Protocol may be outmoded and that a Sarkozy-style carbon tax may be a better option. China and the UK also announced this week a new clean-energy project that will work on carbon sequestration technology to create so-called clean coal.

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Highlights from the last week of China business news.

Inflated figures
China’s third-quarter macro figures came out last week. The trade surplus in October continued to surge, which for once is actually surprising. Expensive commodities worldwide meant that the value of imports was up 25.5% from a year ago, but export growth still outpaced it, leaving the month’s trade surplus at US$27.05, a record high. The central bank said GDP rose 11.5% in the first three quarters, compared to a total increase last year of 11.1%. On the other hand, inflation rose 4.1% in the first three quarters, compared to a 1.5% rise in 2006. Goldman Sachs analyst Hong Liang raised a warning about inflation again (she did this a few months ago at the height of the pork shortage too), saying that the monthly CPI could hit 7% this year. The central bank has done the only thing it can do: raise interest rates. The reserve requirement rate will go up for a ninth time this year, to 13.5%, effective November 26. Central bank governor Zhou Xiaochuan has pledged to fight inflation, but how exactly he plans to do this is anyone’s guess. Goldman predicts two more rate hikes by year’s end.

Planning a buying spree
Remember all that talk about a gush of Chinese capital outflows? Well, it’s definitely in the works. China National Offshore Oil Corp, which reduces to the rather cute acronym CNOOC, was linked to acquisitions in Australia and Nigeria this week. There was a rumor that CNOOC wanted to take over Shell’s stake in an oil project in Australia’s Northwest Shelf region for US$450 million, which was later curtly denied by the Chinese company. Now, a new story has surfaced, saying CNOOC wants to hand over US$900 million to Shell, again, but this time for almost 50% in two Nigerian offshore blocks. No comment from CNOOC.

But commodities acquisitions aren’t really news - banking buy-ins, however, are. The FT broke the news - citing anonymous sources - that China’s top three banks, Bank of China, ICBC and China Construction Bank, approached Singapore’s Temasek Holdings to buy its 17% stake in Standard Chartered. The contacts were “informal and discreet,” which could mean anything, really. In any case, no deal is on the cards - Temasek isn’t selling, and Standard Chartered isn’t keen on having its independence questioned by having the Chinese as its largest stakeholder. An ICBC official denied that any such offer to Temasek took place. Lastly, the much-ballyhooed China Investment Corp revealed that it’s a cornerstone investor in China Railway Group’s Hong Kong listing. The sovereign fund will take US$100 million, the biggest institutional stake, in the H-share offering. This is its second move after buying into Blackstone months ago.

Singapore boosts its guanxi
China and Singapore indulged in a week of cozy relationship-building, with top officials of both countries meeting here and in the land of the Merlion. Singapore’s Lee Kuan Yew told Singapore’s newspaper, the Straits Times, that the man tipped to be Hu Jintao’s successor, Xi Jinping, belonged to the “Nelson Mandela class of persons,” upon meeting him for the first time in China. Meanwhile, Premier Wen Jiabao spoke candidly at a conference in Singapore, saying that illegal money flows threatened China’s stability and that his government would have difficulty reaching the environmental targets they set for themselves. This culminated in the announcement that China and Singapore would build an “eco-city” together in Tianjin, that hot economic development zone the central government is now so keen to promote. It brings to mind another Singapore-China project, the Suzhou Industrial Park, which was started when China was still trying to encourage industry in the Yangtze River Delta. More eco-cities are a good idea, because hopefully it will mean hearing less disturbing news, like the report this week about China’s increasing appetite for nuclear energy, and how it has just signed a landmark deal with Kazakhstan to buy the uranium it needs to build 40 new nuclear power plants by 2020.

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Highlights from the last week of China business news.

The petroleum pinch
The price of crude oil is at a historic high, and China is feeling the pain. Beijing raised gasoline and diesel prices today by almost 10% as crude oil nearly hit US$100 a barrel, despite guarantees that it wouldn’t raise prices at all this year to help keep inflation low. Looks like you can forget about that for now. Price pressure has forced small refiners to stop operations and created fuel shortages around the country. Even state-run oil and gas behemoth Sinopec was grumbling. China complained about the ridiculous state of oil prices at the OPEC energy roundtable last week, but to no avail, it seems. It’s not just oil that’s in short supply. Iron ore prices are projected to increase by up to 50% next year, thanks to China’s appetite for steel. Mining companies like Australia’s BHP Billiton are eager to cash in on this; it’s proposed a new pricing system that will make the commodity much more expensive for Chinese steelmakers. The commodity crunch is not all bad, though: It could generate demand for things like hybrid and clean-fuel cars, like the ones GM is starting to develop for the Chinese market.

The Asian space race heats up
A new space race has begun in earnest. As we mentioned last week, China and Japan now have probes orbiting the moon, following China’s successful launch of its module last week. Days later, it announced that it plans to build a new launch base on Hainan island, better known as China’s tropical getaway. The ambitious plan for the base includes relocating 6,000 people - a trifling number next to the multitudes displaced by other large-scale national prestige projects in China. It’s scheduled for completion in about five years. Why the haste to build a new base? It’s because China wants the optimal low-latitude location for its new series of Long March 5 rockets. Rockets launched from lower latitudes can carry larger loads, which incidentally is exactly what the new rockets will be designed to do. They’ll carry heavier loads of communications satellites and lunar probes, and will be launched from the new Hainan base. India is scheduled to join the fun next April, when it is slated to launch its own lunar probe. Last country with a man on the moon is a rotten egg!

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