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China makes strategic use of commodity collapse

BEIJING (Reuters) - China’s government is using the collapse in commodity prices to further its domestic agenda, with support for stricken sectors tailored to speed up reform plans rather than rescue ailing companies or prop up prices.

To survive plummeting demand for exports -- a sharp turnaround after several years of booming global demand -- many industries are looking for state help and consolidation.

But China’s policymakers are sticking to their economic blueprints and not letting sympathy for troubled corporates overwhelm longer-term priorities. Instead, they are favoring the strongest in each industry in a drive toward consolidation, and at the same time using low prices as a chance to stock up.

On Monday, it emerged that China was poised to buy up thousands of tonnes of rubber and sugar to create a bigger state buffer of supplies for the future, adding to efforts to enlarge stocks of everything from oil to corn to industrial metals.

At the same time, however, it’s letting small coal mines go to the wall, seizing a chance to make good on years of rhetoric, as well as allowing smaller, less efficient metal producers go under.

“As the fundamental balance moves toward a liberal supply of coal, it is an opportune moment to close small mines and speed up restructuring and consolidation of coal resources,” Zhang Guobao, head of the National Energy Administration, said this week.

The government’s State Reserve Bureau has begun building up government reserves of metal, buying around 300,000 tonnes of aluminum and 30 tonnes of indium and starting negotiations to add to its zinc and copper inventories.

The timing could hardly be better. Shanghai aluminum futures halved in the second half of last year to a record low of 10,125 yuan ($1,482) per tonne. Prices have fought back to 12,000 yuan, still a level not seen for 15 years. Copper and zinc have fallen by two-thirds since their peaks.

“The authorities are thinking about the issue from a strategic point of view,” said a senior researcher at the SRB, who asked not to be named.

“As almost all raw material prices went sky-high in the last few years, China has not built up some of the key state reserves. Now is a much better time to stock up,” said the SRB researcher.

China has not revealed how much of each metal it plans to buy, but several sources have put the target for aluminum at 1 million tonnes in total, equivalent to November production at all of China’s own smelters.

PICKING WINNERS

When the government does act, independents lose out to state companies that are ear-marked for success and survival in a streamlined, consolidated future.

A 4 trillion yuan stimulus package, for example, includes a massive railway building program.

A major beneficiary will be Hebei Iron & Steel Group, whose three listed subsidiaries -- Tangshan 000709.SZ, Chengde Xinxin 600357.SS and Handan 600001.SS -- are merging to form China's top listed steelmaker, in line with Beijing's wish for the sector to coalesce into a few big and more efficient players.

Meanwhile, small producer Singapore-listed FerroChina Ltd FERR.SI called in administrators for its Chinese subsidiaries in November, a month after another Singapore-listed firm, Delong Holdings DELO.SI, said it had cut back production in China.

There is a parallel plan for the coal sector, where the two top miners, Shenhua Group and China National Coal Group, have been blessed with export quotas, giving them a leg-up over smaller rivals who must fight for market share at home.

When the state wants to build up its reserves, it buys from a favoured few. Half the SRB's aluminum supply came from top producer Chalco 2600.HK601600.SSACH.N and the rest from seven regional, state-owned smelters.

The purchase was not generous. One market source said the SRB had refused to pay the price Chalco first demanded and might use competitive bidding in case of future aluminum buying. Analysts said the volume purchased was also disappointing.

“Usually state reserves are to meet several months’ demand at most, especially for emergencies,” said Zhu Baoliang, a senior researcher at State Information Center, a government think-tank.

The government’s shopping spree may offset some of the demand drought but prices are unlikely to rebound unless major buyers, such as carmakers and shipbuilders, return to the market.

NO ILLUSIONS

Only in one sector is the state deliberately bidding up prices -- agriculture. But even there it is for political ends: to appease farmers, one of the government’s key support bases.

Holding stocks of food will enable the government to smooth out supply and demand over the medium term, avoiding sudden price spikes that could inflame public opinion and cause inflation.

By contrast, in metals, the government is just another customer. It wants to avoid a return to massive price rises, so it is investing in cheap assets abroad to ensure future supplies of ore. There are no illusions that holding metals in reserve could help dampen prices if demand picks up steam again.

“No country can control the price trend. Trying to do so would just turn the government into a big warehouse,” said Heng Kun, a senior analyst at Essence Securities. “Base metals have no strategic significance, so the state won’t keep buying them.”

The Industry Ministry has issued a supportive statement outlining policy responses, including “special measures” for the non-ferrous metals sector. But the stimulus package has ruled out any direct investment in polluting or energy-intensive industry.

With Beijing’s actions mainly helping big state firms, local officials are under pressure to bail out smaller players. But they also appear to have adopted a hard-nosed approach.

Yunnan province briefly wowed metals markets with a plan to buy up one million tonnes of base metals, but it soon emerged that local companies were being invited to mortgage their metals inventory, leaving them with all the risk and gifting the metals to the government if they fail to pay back the loans.

“Firms would prefer to raise cash by selling their products. Right now they are still exposed to changes in price,” said Heng.

($1=6.830 Yuan)

Writing by Tom Miles; Editing by Michael Urquhart

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