A recycler of steel and a distributor of metal ores, Armco
Metals Holdings is in the process of acquiring California-based Draco
Resources, which trades, mines, and explores for iron ore. This will diversify
Armco Metals to sell iron ore into varied markets beyond China. Armco Metals
has already been positioning itself as the largest processor of scrap steel in
China, which is a fantastic strategy long term, but short term, it could lead
to volatile earnings, and the Draco Resource acquisition significantly
decreases that risk. To better understand that, an overview of China’s demand
for steel is needed.
Since the mid-1990s, China has successfully adopted a
carefully government controlled Keynesian capitalism, and it shows. In 1990,
China’s GDP was about $356.9 billion, and as of last year, China’s GDP is
around $8.27 trillion. So a country with a population in excess of 1.354
billion people has managed to convert about 63% of its population to middle
class in a span of mere decades. This has been done primarily as an export
driven manufacturing economy with the United States as the main customer. All
you have to do is visit a Wal-Mart and you see that a bulk of the products are
manufactured in China by our industries and sent back to America. As a result, we
have a huge trade deficit with China as we are buying tons of products from
them and they are netting large amounts of U.S. dollars as a result. China
cannot convert all those surplus U.S. dollars into Yuan as that will drive
their currency up and cause inflation, so instead, they are net buyers of our
U.S. Treasury bonds, and as a result, China now owns about $1.2 trillion of our
$16 trillion or so of U.S. national debt.
It hasn’t always been a straight line of growth. As we are a
huge customer of China, at the beginning of 2009, shortly after the Lehman
Brothers collapse and the beginning of our financial crisis, we stopped much of
our buying and China’s manufacturing collapsed with a loss of 30 million jobs
in China. Nine months after that, the IMF did a study in China and discovered
that since the beginning of 2009, China had lost only 3 million jobs. So how on
Earth did China managed to create 27 million jobs in only 9 months? Massive
infrastructure spending on roads and further on high speed rail, and banks were
aggressively encouraged to lend to the real estate sector. With a huge
population, China has massive labor surpluses, and to avoid social unrest and
political instability, the government has to either absorb that labor surplus
or violently suppress it. So, the country has been absorbing the surplus labor
by debt-financing infrastructural and fixed-capital formation projects on a
very large scale.
Not a democracy, the government of China can probably be
best described as one of responsive authoritarianism, as the government heavily
polls and surveys the population much the same way as we are heavily polled and
surveyed in the United States. There is a constant worry of social unrest, as
the country spends more on internal security than on military defense. A busy
manufacturing sector has successfully increased prosperity and kept employment
high enough to avoid social unrest.
The world’s second largest commodity market is iron ore.
Central to the world’s economy, iron ore is the main ingredient for
manufacturing steel, and steel represents almost 95% of all the metal consumed
in the world: ships, buildings, bridges, cars, household appliances, and so on.
What is China’s role in the steel market amid all of China’s fantastic economic
growth? China has by far, become the largest producer and user of steel on the
planet. Going all the way back to the 1960s, the pricing of steel was primarily
determined by secretive agreements between mining companies and steel
producers. As China became a powerhouse, they refused to participate in these
benchmark deals practices, and forced all quarterly contracts to be linked to
the iron ore spot market with hybrid contracts.
Over the past few years, China produced about 680 million
tons of steel per year, and if they were cranking out a full capacity, could
produce in excess of 850 million metric tons. At most, only 4% of the annual
production of steel is exported, and most production is used for consumption,
but as infrastructure spending has tapered off, it is known that China has
built up a huge excess inventory of conceivably a few hundred million tons of
steel. In the short term, there are signs that the current round of economic
growth is slowing. There have even been news stories of luxurious ghost cities
that have been built that the average Chinese can’t afford to move into, but
are attractive hard asset investments of the wealthier Chinese. As Chinese
wealthier elites have been screaming at the ruling Chinese Communist Party for
tax cuts, and public investments are slackened, it clearly looks like it will
be difficult for China to continue to be literally half the world’s global iron
ore consumption. In the short term, iron ore prices are expected to soften, as
global economists sit and hope China’s slowdown manifest as a soft economic
landing and not some hard crash. So far, China’s utter lack of democracy has
made for exceptional economic management of their capitalism, so odds favor a
soft landing.
More to the point, we need a slackening in demand for iron ore
as we appear to be hitting a global resource limit. The Worldwatch Institute
has suggested that our planet will run out of iron ore in about 64 years
assuming a conservative 2% annualized growth in demand, and the demand from
developing countries has been much higher. Indeed it has been suggested by a
number of analysts that the easiest to mine areas are already depleted and
future mining is getting more complex, costly, and dangerous. Just within the
past two years, India’s government appointed Shah Commission has warned that
India may run out of iron ore with one decade. Out of economic necessity,
India’s government lifted an iron ore mining ban in the state of Goa anyway,
though set tight limits on the production.
What does this all mean for Armco Metals Holdings? The
company has more than ten years of experience in sourcing and distributing
metal and non-ferrous metal ores to the Chinese steel industry and is very well
entrenched. They have longstanding relationships with more than 100 medium to
small-sized metal producers throughout the People’s Republic of China. The
development of business relationships with Brazil, South Korea, and India, as
well as the recent acquisition of Draco Resources, has diversified the company
away from sole dependence on the current China business cycle. The scrap steel
recycling business in China is highly valuable long term as we face a future of
resource depletion in the future. All of this places Armco Metals Holdings in a
good position for steady, long-term growth.
For more information, visit www.armcometals.com
About QualityStocks
QualityStocks
is committed to connecting subscribers with companies that have huge potential
to succeed in the short and long-term future. We offer several ways for
investors to find, evaluate, and learn more about investing in these companies.
