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China’s uncertainty principle

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It's a basic rule of investing that you should distinguish between risk, which is largely measurable, and uncertainty, which isn't. Embrace the former and, unless you have nerves of steel and deep pockets, be very wary of the latter.

Anyone planning to ship scrap to China in recent weeks would certainly have been reminded of the difference between the two.

The Chinese scrap trade has never been simple sudden tightenings of customs inspections, contract defaults and sharp swings in demand have always posed risks for sellers. The rewards—$500-a-tonne ferrous scrap at the docks, for example—have recently been enough to justify them.

April's announcement by China's Customs Bureau that it was planning new rules for scrap imports was another matter. Depending on who you spoke to, the rules would ban all loose scrap, require shippers to bale or bag all material, or effectively shut out some mixed-grade shipments. Or none of the above. "From first-hand discussion with Customs people, I can tell you that they don't exactly know how to enforce these regulations yet," one industry official said.

Rather than risk, this was uncertainty—an unpredictable, opaque rule-making process that no-one is quite sure will be implemented, or what the impact will be even if it is. And it's something that everyone with a connection to China should get used to.

The arrest and imprisonment of four Rio Tinto iron ore executives is another high-profile example of China's uncertainty principle. The executives were taking bribes, if the Chinese court and subsequent admissions are to be believed. But bribery is rife in China, and the singling out of the Rio employees would seem arbitrary if it wasn't clearly politically motivated. Another charge—of stealing commercial secrets—was even more disorienting, as the "secrets" in question seemed to include such routine market information as Chinese steelmakers' iron ore demand profiles.

Other recent examples abound. China's steel association announced an impromptu ban on low-grade iron ore imports, which few think will work. And provincial authorities in Hunan closed down 99 percent of antimony smelters, sending prices of the minor metal spiraling up.

If there's a common theme knitting all these events together, it's that they are attempts by China's government, industry bodies or bureaucrats to reassert control over the country's freewheeling commodity markets. Paradoxically, that in itself might create more uncertainty, even if in the long term it serves to reduce risk.

That China is changing might be an obvious statement. But the way in which China is changing is itself evolving over time. The government has made it clear that the days of chasing unbridled economic expansion are over; instead, the watchwords are sustainability, consolidation and control (admittedly combined with double-digit GDP growth).

There are two widespread misconceptions about China that Beijing can impose its will on industry and the provinces—it often can't—and that economic development has reduced the role of central government in the economy. In fact, China's state power is on the rise and likely to keep on rising. In metals, that likely will mean a more consolidated steel industry, with a handful of mills exercising greater pricing discipline and purchasing power; more regulations; and even a crackdown on some private enterprise, if one theory for the Rio arrests—that they were part of an attempt to rein in China's privately owned steel sector—is correct. Any of that sound familiar?

If Beijing gets its way, the days of China as a "Wild West" economy could be coming to an end. That will eventually make China an easier, if potentially less-profitable, place to do business. But reducing risk in the long term is likely to increase uncertainty along the way.

KEVIN FOSTER

Managing editor


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