Chinese Profits: Bad for Metal prices?

Metals investors globally were cheered this week by good news from Aluminum Corp. of China (A.K.A. Chalco).

The aluminum giant swung back into profitability for the first time in a year during the first quarter. Chalco enjoyed net income of 627 million yuan ($92 million) for the past quarter, as compared with a loss of 1.9 billion yuan ($280 million) in Q1 2009.

Good times appear to be back for the company. Chalco's plants ran at more than 90% of capacity in Q1, buoyed by rising aluminum prices in Shanghai (and around the world).

This is exactly what the Chinese government wants to see.

In the wake of the financial crisis, one of the biggest stories for the metals was buying of copper, aluminum and iron ore by state-run Chinese firms. At the time, this buying spree was attributed to China's "insatiable thirst" for metals, needed to fuel rampant infrastructure development in the country.

But reading between the lines, there appeared to be a different explanation for the buying.

In several speeches early in 2009, Chinese government officials talked about the importance of raising domestic metals prices. The reason? Staving off unemployment.

Many of the large Chinese metals producers run at very high operating costs. In fact, just this week Citigroup commented that Chalco's attempts at cost reduction over the past year have been largely ineffective, and that the company "could face more pressure with higher coal prices and potential power tariff adjustments."

Because of the high op costs, Chinese producers need high metals prices in order to stay profitable. When prices fell late in 2008, Beijing worried that low prices would put high-cost producers out of business.

Widespread shut-downs mean unemployment. Something the Chinese government fears. Revolutions are born when workers become discontented.

Keeping metals companies in business was a top priority. And that meant getting metals prices up. Many of the comments from Beijing early in 2009 suggest this was the primary goal of metals stockpiling. Securing supplies for infrastructure building was secondary. (A fact becoming glaringly apparent, with most of the stockpiled metal still sitting in storage. Very little building appears to be happening.)

Fast-forward a year and the government is finally getting what it wanted. Producers like Chalco are making money again. Operations are running at full capacity, with managers even eying expansions. All good for employment.
The question now is: will metals buying by the Chinese state drop off? With the mission accomplished, can Beijing afford to relax in the metals markets?

And what effect would this have on prices? Speculators and buyers from around the world have stepped into the metals markets over the past year, taking some of the pressure off Beijing to be the "buyer of last resort".

If the Chinese government does back off, it will be up to these players to support the market. We'll see how deep their pockets are.

By. Dave Forest of Notela Resources