Commodities are king

Analysts across the globe are proclaiming that the bull cycle of the worldwide commodities market is well upon us. In China, this is taking place alongside a confluence of industry reform and strong stock markets, which has yielded a flood of initial public offerings from Chinese commodity firms.

“These IPOs are a function of many things, the commodity boom is starting to mature, and these companies have restructured to the point that private investment makes sense,” said Andrew Driscoll, head of resources research at CLSA.

Regardless of the specific reason, investors in Hong Kong, Shenzhen, and Shanghai have been treated to a historically unprecedented choice of new miners and refiners.

Roll of honor

In July, lead and zinc producer Western Mining raised US$817 million on the Shanghai Stock Exchange while China Coal, which raised US$1.9 billion in Hong Kong last December, is planning a Shanghai IPO for later this year. The retail portion of China Coal’s Hong Kong offering was oversubscribed 182 times and a similar response is expected from mainland investors.

China Molybdenum and ZhaoJin Mining  have also made IPOs in the previous 12 months – raising US$900 and US$324 million respectively – to join a fast-growing list of Chinese commodity firms active in the capital markets.

This explosion in commodity offerings is no surprise, according to Simon Toyne, an analyst at Numis Securities.

“It’s a good time to raise capital for mining anywhere in the world right now,” he said. “We’re looking at a very bullish market structure over the next decade, and much of that is due to China.”

Unprecedented demand for commodities – China’s rapid growth has seen its share of global aluminum, copper and steel consumption rise to one third from 5% two decades ago –  has not only been good for investors. The recent rush of IPOs in China’s mining sector indicates that Beijing also sees the boom as an opportunity to engineer changes in the way its state-owned firms conduct business.

“The government is pushing for consolidation in these industries,” said Driscoll. “Capitalization will allow these companies to pursue a strategy of M&A … and create national winners.”

China’s resource extraction sector is dominated by a bewildering variety of small mines associated with local governments and an even larger number of private mines operating on the margins of regulatory oversight.

As capitalization rolls forward, major mines will have the funds necessary to widen production, exploit economies of scale and push the smaller, less safe operators out of business.

While the potential advantages are clear, this strong reception for commodity stocks is also a source of concern.

Western Mining saw its share price rise 144% on its trading debut and China Molybdenum posted a gain of 59%. Commodity plays are top picks in a market where demand has become insatiable. In the 12 months to July, mainland stocks rose an average of 97% on their first day of trading compared to 22.5% in Hong Kong, the Financial Times reported. This translates into a collective mainland gain of US$24.4 billion.

This has left analysts wondering whether prices are sustainable.

“There’s a huge weight of money chasing a very small number of shares,” said Toyne. “Most of these firms only offer a small stake that doesn’t come close to satisfying the demand for shares.”

These sentiments are echoed by Beijing-based independent energy analyst Jim Brock who believes the price-to-earnings ratios of large firms such as Shenhua Energy have become too aggressive. However, he accepts that they may fall in the long-run as more firms enter the market and investors are presented with a wider choice of lucrative places in which to put their money.

Despite analysts’ concerns, most of them remain confident about the long-term future of Chinese commodity plays.

“Although it might look like a bubble, we are talking about a fledging market, and the premium [that commodity stocks command] could remain for a very long time,” said Toyne.

It is also worth noting that commodity firms operate in state-owned, competition-protected industries that supply materials essential to China’s continued economic growth – their futures are as secure as that of the country as a whole.

There is some speculation that this capital market activity represents a serious step towards privatization and greater accountability. But analysts are quick to point out that the commodity share offerings are relatively small, with the state typically retaining a 65-90% interest.

 “All in all, [the IPOs] are a good thing … one of the reasons for China’s planners to go through with this has been corporate governance,” said Geoffrey Cheng, an analyst at Daiwa Institute of Research. “But this is a gradual process and it will probably take quite some time.”