China's Weak Iron Gambit

 

 

The commodities world has been watching the iron ore pricing skirmishes in Asia between the largest Chinese steelmakers and the likes of BHP Billiton (NYSE: BHP), Rio Tinto (NYSE: RTP), and Brazil's Vale (NYSE: VALE).

These big miners supply the iron ore that is vital to the manufacture of steel. If you have kept up, you also realize there's been a new, unexpected, and goofy twist in the situation.

The new twist involves a number of Chinese steelmakers signing on for iron ore supplies with Australia's Fortescue Metals, that country's third largest ore producer. In exchange the Chinese would lend Fortescue up to $6 billion. The funding is intended to set the company on the road to the increased size and importance it is targeting.

There are two major problems in this new deal, however. The first is that its price works out to a reduction of about 35% from last year's level -- less than the Chinese had been demanding of the bigger suppliers. And beyond that, it appears that Fortescue will supply about 20 million tons of ore to China, or a piddling portion of the nation's needs.

As you know, the prices of most commodities ran like scalded dogs last year. In the process, the big three iron ore suppliers raised their prices to the steelmakers substantially. But this year, with commodities prices having tanked, iron ore levels were bound to dip.

And dip they have. The first shot out of the gun was a 33% reduction from last year's level, negotiated between Rio Tinto and Japan's Nippon Steel. That level was intended to serve as a benchmark for subsequent contracts. And indeed, most Japanese and South Korean manufacturers did follow along. But the bigger Chinese producers held out for a larger cut, at least 40% off the 2008 level.

You have to believe that the Chinese remain miffed about their inability to double their stake in Rio through their Aluminum Corp. of China (NYSE: ACH). Rio was seeking funds for debt repayment, but found the money elsewhere. Hence China's recalcitrance.

From a Foolish investment perspective, I continue to like the big three miners, especially given a longer-than-normal investment time horizon. And of that threesome, I'm especially a fan of BHP for several reasons, including its active and promising oil and gas operations.