Chinese Stock Dive Buries Mining Stocks

BHP Billiton, Rio Tinto and othersrelying on China demand to maintain lofty metals pricessaw their shares take a hit on world bourses

Mining companies such as BHP Billiton, Rio Tinto Group, and Anglo-American have scored bumper profits in recent years thanks to China's seemingly insatiable demand for copper, nickel, and other metals.

On Feb. 27, though, they found out just how painful being so reliant on the world's fastest-growing large economy can be. To reign in liquidity and dampen speculation, China raised bank reserve requirements and green-lighted a task force to police investment activities, causing stocks to plunge 9% (see, 2/27/07, "A Rough Day for China Stocks").

Shares of London- and Melbourne-based BHP Billiton (BHP), the world's No. 1 mining company, followed suit, falling 6% in London trading and 5% by midday in New York. The world's No. 3 miner, London-based Rio Tinto (RTP), fell 5.3% in London and 3.9% by midday in New York.

It also wasn't just China that sent mining stocks reeling. Reports in South Africa's Business Day newspaper said that the country's finance minister wants to impose a windfall profits tax on metal manufacturers on top of the royalty payments they already pay.

That contributed to a commodities rout that also dragged down shares in giants such as Anglo-American (down 5.3% on the London Stock Exchange), Xstrata (down 7% in London), and Parktown (South Africa)-based Gold Fields (GFI), off 3.5% in New York trading.

North American producers were less affected by the sell-off. Denver-based Newmont Mining (NEM) was off 2.7% at midday on Feb. 27, while Toronto-based Barrick Gold was off just 1.5%.

"People are worried that things are going to be growing a little more slowly in China in the future," says Charles Kernot, director of metals and mining at Seymour Pierce in London. "Chinese authorities still recognize they need economic growth—they just want to manage it." Investors, he says, are using today's developments to "take profits."

What profits they have been. Annual average prices of commodities such as copper and nickel hit their highest levels since the 1970s last year. That has turned into a bonanza for mining companies such as BHP, which said on Feb. 7 that profit for the six months ending Dec. 31 jumped 41.3% to a record $6.16 billion (see, 2/7/07, "BHP Billiton CEO Ending on a High Note").

BHP said then that it expected prices to remain high as China's demand for commodities helps offset a possible U.S. economic slowdown—one reason investors may have spooked at the prospect of potentially slower Chinese growth. As of Feb. 26, BHP's shares had been up 42% since the start of 2006.

Rio Tinto, meanwhile, posted a 25% gain in second-half profit to $3.6 billion on Feb. 1, citing higher commodity demand, adding that capacity was "fully stretched." Its shares were up 30% since the start of 2006, as of Feb. 26.

The changing picture in China could alter longer-term prospects for the metals sector. JP Morgan (JPM) analyst Jon Bergtheil said in an analyst note that poor demand for metals in China in the final quarter of 2006 was seen as "keeping their metal-buying powder dry" until after the Chinese New Year.

But now, Bergtheil says, investors are starting to worry that this is more than a blip. "The fact that Chinese investors have come out into the New Year hitting their equities hard has caused nervousness in the mining equity sector that [the] weakness of [the] past few months may be more indicative of genuine demand trends than 'timing' aspects," Bergtheil wrote in his note.