China's need for raw materials is both a threat and an opportunity.
Until recently, most Americans believed that the biggest threat China posed to the U.S. economy was the Asian behemoth's ability to draw manufacturing jobs away from our shores by offering our companies a huge pool of cheap, semi-skilled labor.
The manufacturing exodus is going to continue, but now it's clear that China poses an even greater threat to an even greater number of Americans because of its insatiable need for raw materials to fuel its double-digit growth rate.
This month, I'll explain why the low inflation that our country has enjoyed in the past should soon be a fond memory because of China's effect on the prices of basic raw materials. I'll also show how canny stock investors have been taking advantage of the recent surge in commodities prices by purchasing the shares of U.S. companies that stand to benefit from the primarily China-driven demand for these essential products.
China's needs drive prices
As anyone who has taken even an introductory college course in economics knows, commodities prices are determined by the simple forces of supply and demand. When supply and demand remain in balance, as they did for most of the past decade, prices can stay relatively stable. However, when a new element is introduced into the mix, the delicate balance that exists in raw materials ranging from cotton to copper can suddenly be overturned and prices of these basic goods can move sharply. Anyone who is old enough to have waited in a gas station line during an OPEC crisis can attest to that fact.
What's happened in China is that increasing internal consumer demand from the country's 1.3 billion people has quickly combined with rapidly growing manufacturing exports to create a huge demand for all types of raw materials. And as China, which is home to 22% of the world's population, continues to prosper, its effect on worldwide commodity markets will grow even larger and more urgent.
Inflation appears inevitable
While Americans continued to reap the advantages of low inflation and attractive mortgage rates in 2003, they should also have been taking a sobering look at how the prices of many commodities were increasing as much as 50% in just one year. Price rises of this magnitude in such basic goods as cotton, soybeans, copper and scrap steel almost certainly will lead to renewed inflation down the road as manufacturers eventually have to boost prices to cover their cost of production.
If the average American hasn't noticed the commodities surge, many sharp stock market investors have. In 2003, many of Wall Street's biggest gainers were the shares of companies that either produce or process basic raw materials.
For example, the shares of copper giant Phelps Dodge soared from a low of 30 to a price of 75 at year end. Nickel producer INCO went from 17 to almost 40. The gains were even greater in scrap steel, where one of the leading processors, Metal Management, rose from six to 35 and Schnitzer Steel did even better (from 10 to 60).
Savvy investors can profit
The exceptional performance of commodities-related shares in the year 2003 proves that, for stock investors, every problem creates a new opportunity. Investors who are early in discerning change can move their money into sectors that stand to profit from the new reality. Lately, the move has been to get into raw materials stocks and ride them.
Mr. Helzner has written more than 50 articles
on stock investing for Barron's. He's been a regular stock market
columnist for other business publications and was a member of the equity
research department of a major regional brokerage firm.
Optometric Management, Issue: March 2004