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The China growth story should sustain a strong Australian economy while painting a bright outlook for the resources sector in the absence of a double-dip global recession.

Research analyst Carey Smith says Australia avoided a recession in 2009 primarily due to China’s “insatiable demand” for our commodities, mostly iron ore, nickel, coal, copper and zinc. Smith, of Alto Capital, says bilateral trade between Australia and China totalled $US78.2 billion in 2009 and is forecast to grow to $US91 billion in 2010. This compares to $US8.5 billion in bilateral trade in 2000. Smith has established a portfolio of stocks that he expects will benefit from a strong Chinese economy forecast to grow by up to 10 per cent in 2010.

Rio Tinto and BHP Billiton will continue to be major beneficiaries of Chinese demand for commodities.  Smith says Rio Tinto’s biggest customer China buys huge quantities of iron ore, copper and aluminium each year.  “Rio, as the second largest resources company in the world, is very dependent on China,” Smith says. “A strong China enables Rio to increase production by investing in large multi-billion dollar projects. If China’s strong, Rio can be confident there’s a market for its products at a suitable price.”

A similar scenario applies for BHP Billiton. “The world’s largest resources company has the most to gain in straight dollar terms from China maintaining its strong growth,” he says. “BHP’s iron ore, base metals and petroleum products are keenly sought by China.”  Rising iron ore prices highlight China’s demand for commodities.

Smith says that in 2003, iron ore was selling for $US19 a tonne; in 2006 it was $US45 a tonne; last year it was fetching $US60 a tonne and its 2010 price is forecast between $US90 and US$100 a tonne. Similar percentage price increases applied to coking coal (used for making steel) and thermal coal (for generating electricity). BHP and Rio also sell iron ore to Japan, Korea and several other countries.

Fortescue Metals Group is a one-product company and sells all its iron ore to China. “For this reason, Fortescue Metals is the most sensitive to any slowdown in the Chinese economy,” Smith says. “However, and importantly, the group is confident in the Chinese story with plans to increase production from 40 million tonnes a year to above 100 million tonnes a year over the next few years.”

Gindalbie Metals is stgeloping the Karara Iron Ore project in a joint venture with China’s second largest steel maker AnSteel.  The magnetite deposit is considered world class and AnSteel’s commitment is evident after investing $573 million in Gindalbie and the project. Smith says AnSteel is also responsible for arranging $1.3 billion in debt finance from Chinese institutions to invest in the project. “Gindalbie is dependent on Chinese confidence in the iron ore market to ensure that construction can start on schedule later this year,” he says.

The Australian Bureau of Agricultural and Resource Economics says the value of advanced minerals and energy projects stood at a record $112.5 billion late last year. It says the $112.5 billion is spread across 74 projects – 38 energy, 31 minerals and five mineral processing. ABARE concludes the increase in planned capital expenditure reflects expectations of growing demand for minerals and energy commodities in the medium term. Western Australia alone accounts for about 83 per cent of the capital expenditure on advanced projects – eight oil and gas and eight iron ore.

Engineering services companies, such as Downer EDI and Monadelphous Group, are playing a secondary role in the China story via the design, construction, operation and maintenance of large resource projects. Downer EDI also provides maintenance services for rail locomotives and wagons. Smith says: “The increase in exports of bulk commodities (iron ore and coal) to China is resulting in stronger demand for Downer’s services, particularly the rail division, as most bulk goods are transported via rail from the mine to the export port.” He says Monadelphous Group profits have increased from less than $5 million in 2000 to almost $75 million last year. Continuing strong performance depends on China’s growing economy demanding more of Australia’s resources.

Smith says Independence Group appeals as it had $137 million in cash and equivalents on its balance sheet at December 31, 2009. And, this mid-tier nickel producer had no debt. “The cash generated by the strong nickel price is used to pay dividends and to accumulate a cash pile to fund its 30 per cent stake in the world class Tropicana Gold project,” Smith says. Another nickel producer Western Areas offers a top growth pipeline of nickel assets. “But the company depends on a strong, sustainable nickel price to give it confidence to spend the required capital to bring new projects into production.”

Smith suggests investors examine individual company performance and its outlook before investing. Some small explorers can hitch a share price ride on good commodity and outlook news, but can’t fully capitalise as they’re not producers. And, good news can be quickly factored into a producer’s share price, leaving eager yet inexperienced investors buying at the top of the market. “Australia has hitched many of its wagons to the China story and relies more than ever on its strong economic growth,” Smith says. “If China’s economy was to significantly slow, it would reverberate through the Australian economy and particularly Western Australia’s. China is Australia’s biggest trading partner.”

But there’s a strong argument that China will continue to grow for at least another decade as it’s only part way through industrialising its economy, and any immediate spare capacity (office, accommodation and infrastructure) will be quickly filled by people migrating from rural to urban areas. Also, a global economic recovery, particularly a boost in US consumer spending flowing from improving jobs numbers, would be good news for China and Australia.

Smith says Navitas Limited, a provider of educational services for overseas students wanting to study in Australia, is likely to benefit from China’s prosperity. Navitas provides English language training, university preparation and programs, career advancement courses and migrant settlement services.  “There’s more Chinese students studying in Australia than any other overseas group,” Smith says. “The better the Chinese economy performs, the bigger the pool of Chinese students who want to study here.”

 COMPANYASX CODE SHARE PRICE 5 MARCH 2010
 Rio Tinto RIO $74.40
 BHP Billiton BHP $42.28
 Fortescue Metals FMG $4.88
 Gindalbie Metals GBG$1.08
 Downer EDI DOW$7.74
 Monadelphous Group MND $14.79
 Independence Group NL  IGO$4.20
 Western Areas NL  WSA $4.83
 Navitas Group NVT$4.89

 

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.

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