By now most investors are aware of the immense impact China has had on global commodity markets. In many cases, prices have exploded upwards as the country's billion-plus people modernize its economy.
But as I suggested in a recent article on the U.S. thermal coal market — not all commodities are equal — not even close. [Read: "Say Goodbye to One of America's Largest Industries"] To benefit from the global growth story, and in particular, the China growth story, you need to know which commodities to buy.
Here are China's top five commodity imports and the outlook for each. At the end, I'll tell you which commodity is my favorite play.
Demand for rubber is closely related to the demand for automobiles, with the commodity used primarily in making tires. While the U.S. automotive sector has been struggling in recent years, China's has been booming, leading to a sharp increase in rubber imports.
There is no easy way to invest directly in rubber. Close to 95% of natural rubber is produced in Asia, while synthetic rubber is produced by large chemicals companies.
An interesting tidbit is that soybeans are thought to have originated in China. It is somewhat ironic then that the country is now the single largest importer of the commodity. As a matter of fact, China's demand for soybeans has been outstripping domestic supply since the 1990s. But that's not necessarily a bad thing, for it is a reflection of a nation that is getting wealthier. What we have seen is that as their per capita income rises, the Chinese are demanding more and more foods rich in protein, particularly animal protein. This has led to increasing demand for soybean meal, which is used in animal feed.
As China's No. 1 agricultural import, soybeans are a good play on the country's growth, and one that is tied intricately to the Chinese consumer. Though well off the all-time highs registered in 2008, soybean prices have been gradually rising in recent months. With Chinese soybean imports consistently increasing (they recently hit an all-time high of 6.2 million metric tons in June), demand should stay strong.
On the other hand, soybean production does not face the bullish supply constraints that are evident in other commodity markets. Output from the United States, the largest soybean producer and exporter, is expected to increase +2% this year, after increasing +13% in the year-ago period.
For investors seeking soybean exposure, short of buying farmland or soybean futures, there is no direct way to play the commodity. Moreover, while there are numerous vehicles where one can receive much broader agricultural exposure, those are far from ideal.
As an important base metal, copper is widely used in rapidly-industrializing China. It is used all across the economy, from building construction (plumbing, electrical power) to infrastructure (power utilities, telecommunications) to equipment manufacturing (industrial, automotive, cooling). China is the 800-lb gorilla in the copper market, accounting for almost 40% of global demand for the metal, which is almost three times the demand from all of North America.
And just as China is by far the largest consumer of copper, Chile is by far the largest producer — responsible for more than one third of the copper mined worldwide. While copper producers do not outright conspire to keep prices elevated, when output is concentrated in the hands of a few producers, the risks to supply are increased — a bullish factor for any commodity.
Prices for copper have been surging recently, and are not that far from the all-time highs of 2008. After China announced its $586 billion stimulus plan at the end of 2008, its copper imports increased significantly and haven't looked back since. The International Copper Study Group expects that worldwide copper demand will rise +4.5% in 2011, after rising +3.8% in 2010. Such strong rates of growth should keep this commodity in high demand for the foreseeable future.
One very interesting copper play that investors can take a look at is Southern Copper Company (NYSE: SCCO). The company derives the vast majority of its output from Peru, the second-largest copper producing country after Chile. Income investors may find the stock particularly compelling, as it offers a 3.6% dividend yield. [See my colleague Tim Begany's recent take on Southern Copper here .]
2. Iron ore
As one can imagine, any economy growing as fast as China is going to need steel, and lots of it. It is little surprise then that the country is by far the world's largest consumer of the metal. In fact, so voracious is China's appetite for steel that its demand actually increased +25% in 2009, while the rest of the world's demand fell by a similar amount. But steel isn't one of China's top imports. That's because the country is also the world's largest steel producer, accounting for 46% of total output. This self-sufficiency has enabled China to become a net exporter of steel in recent years.
Investors should instead be focused on iron ore, a key ingredient in the steel-making process. As is the case with steel, China is the world's number one iron ore producer, but it still doesn't produce enough to satisfy the enormous requirements of its steel industry. Thus China requires a significant amount of imports to bridge the gap between demand and domestic supply.
Iron ore prices are back on the rise, and fortunately, there are convenient ways for investors to gain exposure to this commodity. Publically-traded mining juggernauts such as Vale (NYSE: VALE), Rio Tinto (NYSE: RIO) and BHP Billiton (NYSE: BHP) together control 60% of the seaborne iron ore trade, as well as 35% of global production. Brazilian miner Vale is particularly attractive as the largest exporter of iron ore in the world.
1. Crude oil
The king of all commodities is also China's top commodity import. Now the No. 2 consumer of crude oil in the world, China has made waves as it plays a major role in pushing up prices of this key fossil fuel.
Oil has all the characteristics of a compelling commodity investment: supply constraints and extremely robust demand growth. And that growth is, of course, being led by China. In the past five years, the country's oil consumption has soared, increasing by an average of +6% per year. Demand has risen from 6.7 million barrels per day in 2005 to 9.1 million barrels per day this year. In fact, China accounts for a whopping 37% of this year's global demand growth of 1.9 million barrels per day.
But demand is just half of the oil story. On the supply side, we have the Organization of Petroleum Exporting Countries (OPEC), a cartel of oil-producing nations that attempts to actively manage oil prices to maximize revenue. Together, these countries produce 40% of the world's crude and control nearly 75% of global oil reserves. As non-OPEC producers have been finding it more and more difficult to increase their production in recent years, the onus of delivering supply has fallen to OPEC — a recipe for higher prices.
Despite these bullish long-term fundamentals, oil prices have been stuck in a range between $70 and $85 for the better part of a year. As a consequence of the economic downturn, inventory levels have been elevated, and those will need to be worked off before prices can advance meaningfully higher.
Action to Take –> Buy what China is buying. That's the simplest way to benefit from the growth of this economic powerhouse. While all of China's top commodity imports have compelling fundamentals, an investment in crude oil looks particularly attractive.
Because the commodity faces some near-term headwinds on the supply side, investors have an opportunity to get in before the next big run up. Oil-focused exploration and production companies are the best way to gain oil exposure. Take a look at names such as EOG Resources (NYSE: EOG), Whiting Petroleum (NYSE: WLL), and Occidental Petroleum (NYSE: OXY). These high-growth companies are focused on oil production in North America. Rising demand from China will push up global crude prices, leading to increased profits for these firms. Moreover, because these companies operate primarily onshore in North America, geopolitical and operational risks are significantly lessened. This is in