From Lightning Rods to Toilet Parts

From: Derek Hillen
Sent: Thursday, October 13, 2011 11:24 AM
To: Derek Hillen
Subject: From lightning rods to toilet parts

“The bigger crocodiles must be removed because they have developed a taste for us.”  - Rudy Ayala, village chief, Bunawan, Philippines

Saltwater crocs (“salties” in Australia) are the world’s largest living reptile. They can reach 7 meters in length, weigh up to 2,000 kg and at that stage do whatever they want. The largest living crocodile in captivity today is 6.4 meters long and was recently captured in a swamp in the southern Philippines where it apparently found the villagers sweaty but satisfying. This may because its normal prey, deer, wild boar, etc. is in short supply due to human encroachment on its habitat. Reading this I thought, wow, obviously this sounds just like the China copper market.

Headline news in the FT today quotes the China Non-Ferrous Metals Industry Association saying that Chinese copper inventories were 1.9 mn tons at the end of 2010 – far above market estimates of 1 mn – 1.5 mn tons. The significance of this statement is that while China has been buying copper they haven’t been using it. Copper demand is one of the most reliable indicators of economic growth as it is used in the manufacture of everything from air conditioners to lightning rods to toilet parts. Estimates made, whether back of the envelope or in detailed models, of China’s economic growth have been in part based on “real” copper consumption. Only, it ain’t real. What is going on?

Beijing’s tight monetary policy has encroached upon the habitat of business in China and credit is getting as scarce as hair on Clint Eastwood’s head. Banks aren’t lending to private enterprise so they are turning to the curb market for loans, paying annualized rates of 30-50%. Our commodities strategist, Henry Liu, explains copper importers in China can take advantage of the environment by using a letter of credit issued by a bank to buy a shipload of copper. The copper itself is used as collateral for the LC. It takes two weeks to ship the copper to China whereupon the buyer sells it on the open market upon arrival. He then has six months to pay the bank back. Property developers, as I wrote in my last note yesterday, can’t get bank loans, have been locked out of the debt market and are facing liquidity constraints. Our friendly copper “trader” lends the money to them for six months earning a nice turn at current rates. There have even been reports of property companies buying copper directly, selling it on arrival and financing their operations this way. It is interesting to note that of all the base metals only the copper price is above its cost curve because A LOT of the “demand” is for financial speculation. Copper is preferred over property (illiquid and there are restrictions on purchase) and gold (too valuable and dangerous to store). Rubber in China is also being used this way as imports are up 50% ytd but industrial demand is weak. Conclusions:

1)       Copper prices are in a bubble

2)       China economic growth may be less than forecasters realize

3)       One cannot escape the Law of Unintended Consequences


Eric Wen has released a sector report on the Chinese internet sector (attached). In it Eric identifies five themes, or forces, driving the sector forward:

1)       Migration of PC internet users from client to web

2)       Rise of smartphones and tablets usage promoting mobile internet

3)       Migration of offline companies to online

4)       Emergence of social media

5)       Triple convergence of cable, IP and internet video

The report examines which companies will benefit from the above with the conclusion that Qihoo (QIHU US, Buy) is the clear winner. Eric continues to like Baidu (BIDU US), Tencent (700 HK) and AutoNavi (AMAP US). He initiates coverage on Qihoo and Ren Ren (RENN US, Buy). I met Ren Ren before and wrote about it in an earlier note (“Don’t Eat Sticky Rice”) and the stock is off 20% since then. The “e” should be turned into a “u.” I don’t like this one as they have spent time and money developing a great platform for losing money.


You can get our research by typing MASR <Go> on Bloomberg.


Derek Hillen, CAIA
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