The China Syndrome

A White Paper

By Mid-America Fittings, Inc.

May 1, 2007

 

                            

 

Many, but not all of you, are old enough to remember that 1979 techno-drama “The China Syndrome”.  It was about a female reporter (Jane Fonda) who tries to uncover dangers at a nuclear power plant getting ready to come on-line.

 

The legendary actor Jack Lemmon plays Jack Godell, the foreman at the reactor when an incident occurs.  While the initial incident did not lead to a catastrophic meltdown “The China Syndrome” it did cause him to dig deeper into the inner workings of his plant only to discover that shoddy workmanship had been allowed to go on unchecked by his superiors in order to save a buck.  Godell’s discovery leads to the climatic conclusion that if you have not seen is worth renting if for no other reason than to see one of the greatest single scene performances by an actor without a soundtrack or any other movie magic.

 

I mention the movie as a nexus to our own “China Syndrome” as it relates to everything copper and brass.  For the past twelve months commodity experts have been scratching their heads trying to anticipate the future movement of both the copper and zinc markets, the two key metallurgic elements in brass, as they continue to buck historical and empirical fundamentals.  There appears to be no end in sight to the head-scratching going on around the world.

 

As with any world commodity there are certain and specific market fundamentals that help to establish a commodity’s market underpinnings.  Typical fundamentals, as they relate to both copper and zinc, are current world supply, current world output (growth or decline), world consumption, inflation, currency values, trade balances, interest rates, and good old-fashioned greed.  Then within each specific primary fundamental there are subsets of secondary fundamentals that help to create the primary fundamental profile at any given moment in time.  For example, within the “current world output” primary fundamental there is a subset of secondary fundamentals like labor conditions, weather conditions, plant condition & investment, equipment condition & investment, available capital, etc that shape the primary fundamental.

 

These secondary fundamentals can force a primary fundamental out-of-balance from its normal, historical state of equilibrium.  A practical hypothetical example of this would be labor unrest in the number one copper producing regions of the world—Chile and Indonesia.  This could reduce output to 25% of normal daily output.  That ripple effect can and would take the primary fundamental “current world output” out of its state of equilibrium thus forcing the underpinnings of the global market to give way to higher prices at the COMEX, LME, and Shanghai metal exchanges.

 

Why is it important to be aware of these fundamentals?  In today’s world of global sourcing and global economy you can no longer just look at traditional supply and demand models to determine where a commodity price will settle at any given moment in time.  You have to be aware of all of the possible primary fundamentals that might impact the underpinnings of a given commodity. The realities in our case at this time have lead to the creation of “The China Syndrome”.  China’s first quarter GDP finished up an astounding 11.1%.  Compare that to our own meager 1.3% gain for the same period.  With that kind of national hyper-growth China’s demand for the planet’s resources will continue at hyperactive levels.  China currently consumes one-half of all of the world’s cement, twice the rest of the world’s consumption of copper, ninety percent of the world’s steel and one-third of the planet’s coal production.  These levels of consumption throw the copper “world consumption” fundamental totally out-of-balance and thus destabilizing the underpinnings of the commodity and sending prices soaring to historic highs.

 

At the same time you have the copper and zinc mine operators who love these newly discovered historic high prices for their commodity.  They have quickly learned from the oil producing countries and companies that if you don’t react to demand by providing more supply, which is readily available, you can keep market prices high.  This allows them to make record profits for reinvestment or profit sharing with their shareholders.  So they continue to dribble out additional output at the rate of  4% growth annually.

 

Well the reactor core meltdown occurs to U.S. manufacturers and suppliers, a real “China Syndrome”, when the commodity is in such demand whether real or artificial that the only buyers are those who have enough currency to pay the inflated premium prices.

 

The sad reality is that the U.S. manufacturing sector no longer has the power or ability to control the primary fundamentals for most global commodities, let alone these two key commodities used in the production of brass.  We are now subjected to riding the tides rolling in from the Pacific Rim.  If this trend continues, and we see no viable reason why it will not, then at some point China will be in full and total control of most strategic global commodities and resources.  Once they control the supply of the commodities and resources then they can set the market price for finished goods around the world without worry of competition. That is when the reactor core meltdown of the U.S. economy would be complete. 

 

In conclusion, we see no key fundamental within the copper or zinc commodity moving in a positive direction in the short or near term (see price charts at top of page one).  We also do not hold out much hope for a long-term correction.  The very best that we think that can be hoped for is a price stabilization between the $3.60 and $3.70 per pound plateau for copper and the $1.75 and $1.85 per pound record plateau for zinc during the 4^th quarter of 2007.  We expect the market to trend higher and settle between now and then baring any major geo-political or geo-economic development that would take a key fundamental further out-of-balance.  What this means to you and your business is that you should plan for possibly one, and maybe two “list price” adjustments similar to the one just announced.  Then in the 4^th quarter of 2007 or 1^st quarter of 2008 you may see one or more of those increases rescinded.

 

We urge you to help control the underpinnings of this raw material (yellow brass) by continuing to purchase as much of this commodity from a domestic manufacturer like us.  We recycle all of our brass scrap that is the result of our production directly to the brass mill that makes our raw material rod.  This helps to reduce the amount of scrap the rod mill has to buy on the open market.  When they buy on the open market they are in direct bidding competition with China for that scrap material.  Currently China pays about a 10% premium over other buyers in order to feed their hyperactive consumption.  The less our rod mill has to buy on the open market the less premium they have to pay thus keeping raw material prices more stable.  The more products we can manufacture and sell to you the more scrap raw material we have on hand to send back to the rod mill.  This helps to stave off “The China Syndrome”.  We will also do our best to continue to keep you informed on the current condition of these commodities that impact our finished goods price to you.  Please continue to monitor our web site for the latest information and industry trends.