If you haven’t yet prepared your portfolio for a world with a lot less economic growth, there’s still time. But maybe not as much as you think. The transition from a world led by American consumption to one led by Chinese consumption isn’t going to be seamless. And it probably includes an extended stop-over at Deleveragingville, during which time not all stocks will be treated equally.
The good news out of China – the news that the bulls will seize on this morning – is that the People’s Bank of China cut reserve requirements at banks and injected $63 billion into the economy over the weekend. The Bank is trying to free up liquidity, lower interest rates and generate economic activity. Which brings us to the bad news.
Economic activity in China is slowing down. The slowdown touches all parts of the economy, too. For example, April industrial production (IP) was 9.3% higher year-over-year. But that was the weakest reading for industrial production in three years. It was also lower than the 11.9% rate in March.
Now, an industrial production of 9.3% doesn’t seem like a disaster. It seems pretty solid. It’s certainly not the kind of disastrous figure that precedes a big crash. But you do have to wonder how much you can trust any official government numbers these days.
It’s not so much that the statistics themselves lie. It’s that the people providing the statistics may be lying. They do so in order to inflate their growth numbers to the party higher-ups. High growth is the currency with which you can purchase political advancement. And in any case, the lower IP number had plenty of company in the last week.
April imports in China were up just 0.3% year-over-year. Analysts expected 11% growth. That expectation was based on an average monthly growth rate of 25% in 2011. That string of strong export figures fully supported the idea that China was seamlessly switching from export-led growth to more domestic consumption. Last week’s data challenges the narrative.
Last week’s retail sales figures also showed slower growth, and so did the fixed asset investment figures. That’s the very definition of a statistical double whammy! Both figures represent different growth models.
Retail sales should rise as China’s per capita incomes rise and consumption increases in the economy. Fixed asset investment – the resource-intensive building of roads, houses, bridges, and infrastructure – should gradually decline, at least as a portion of over-all GDP. Less investment, more spending. That’s the simple explanation of what everyone expects to see in China.
But instead you see this: less investing, less spending, less building, less importing, less exporting, and less lending, despite cheaper credit. What kind of a world is that? That’s a world that’s not growing as fast, or is even contracting.
Maybe this is all just a gradual moderation in China’s growth rate. You can grow your economy at double digit rates when you’re coming off a low base, but as GDP creeps up, sustaining that infernal pace becomes impossible. Developing economies grow at double digits. Developed economies don’t.
For Aussie investors, this means be on your guard. The Aussie share market is, by definition, a growth-oriented market. China’s fixed asset investment binge of the last two decades almost single-handedly accounted for the windfall profits from rising iron ore and coal prices.
That’s all changing now. We think it means a shift in the leadership of the commodity sector in Australia. Read that shift correctly and you should be okay. Read it incorrectly and you probably won’t be okay.
Even the New York Times is on to the story, reporting that,
‘China has been the largest single contributor to global economic growth in recent years, and a sustained slowdown in its economy could pose problems for many other countries. Particularly exposed are countries that export commodities like iron ore and oil and rely on demand from China’s steel mills and ever-growing ranks of car owners.’
Hmm. Which ‘particularly exposed countries’ could the Times possibly mean?
Slipstream Trader Murray Dawes is already trading the ‘negative growth’ story. He’s been sending us versions of the Bloomberg chart below for weeks now. It shows the price of iron ore imports in China. The price has been in a steady distribution since late last year, but now it’s turned down.
Murray’s especially interested in this price because he has several short trades on with iron ore producers. One is already in stage-two profit. The others are trending nicely. From a ‘big picture’ perspective, it’s basically a ‘negative growth’ trade. It’s one way to hedge your overall portfolio risk by at least making a little money as things fall apart.
But you don’t need to be excessively negative either. We mentioned that we think leadership in the Aussie resource sector is changing. From whom to whom? From the bulk materials producers to the energy miners, that’s whom and whom!
On the case is our own Dr Alex Cowie. He’s travelled to Adelaide for the annual conference of the Australian Petroleum Production and Exploration Association (APPEA). He’s writing notes this week for our sister publication Money Morning. You can see his posts this week at www.moneymorning.com.au
The conference starts today but it’s already in the news. ‘The head of the world’s fifth-largest oil company wants to turn Australia into a global energy hub on a par with the Middle East, Canada and Russia, after a 20-year absence from the local market,’ reports Angela Macdonald-Smith in an exclusive interview at the Australian Financial Review.
Hey, that sounds familiar. We told a similar story last year in Revolution in the Desert. We wrote about the new ‘energy superhighway’ between China and Saudi Arabia and its direct impact on natural gas, both conventional and unconventional. We told our Australian Wealth Gameplan readers about three companies operating in Australia’s Cooper Basin that would benefit most from this big global energy shift. It’s worked out pretty well so far.
And it could get even better. Christophe de Margerie, the CEO of French oil giant Total, says the company will invest at least $16 billion in Australia over the next five years. Total is already invested in the Santos LNG project in Gladstone and the $34 billion Icthys LNG venture led by Inpex in Darwin. But Christophe de Margerie is ready for more.
‘We think it is the right time to see if, on top of those two projects and all the acreage we have off the north-west coast, we can do more with local companies, and to start, with Santos…We have said it already to Santos, we will meet with them and see what we can do from there – and not only be definition on LNG coming from those coal-bed-methane fields. I come with a totally open mind.’
Hmm. That sounds to us like Total might have an interest in shale gas assets in Australia. Despite BHP’s cost blowouts on its US ventures, Total is thinking long-term, as a major integrated oil company must. New reserves must replace annual production on a constant basis. That means planning years ahead, so that exploration can yield actual resources that enter into production when you need them (or when your customers need them, to be more accurate).
This is probably the bright spot in an awkward moment in the Aussie share market. The China growth story is evolving. The next ten years on the Aussie market aren’t going to look anything like the last ten years. You can’t afford to invest as if nothing will change. But what CAN you do?
Well, we’d expect more de-leveraging. JP Morgan’s $2 billion trading loss reported last week – admittedly a pittance relative to the size of the company’s balance sheet – is more evidence that the world’s financial markets are highly leveraged. You have trillions in assets sitting on top of a very small sliver of equity. In fact, the leverage is probably higher and more dangerous than in 2007, when the global financial crisis began.
The world’s financial markets are more fragile and interconnected now than they were five years ago. That means commodities, resource stocks, and the Aussie dollar are all in danger of big falls if the ‘risk off’ mentality leads to more deleveraging in the financial world. You saw what happened in 2008. Now imagine that was just a preview. And it’s not something that could happen far off in the future. It’s something that could happen now, in 2012.
It’s hard to reconcile that gloomy forecast with a bullish forecast on energy, but if you’re looking 20-30 years out like Total, it’s not as hard. It means a falling Aussie dollar is the perfect opportunity to buy Aussie energy assets on the cheap. You then have a tangible asset that’s at the centre of the Asian growth story for the next 30-years – natural gas.
Of course most investors are not investing for the next 30 years. Most investors can’t afford another bad three years, or another three years of average returns. So if we’re right about the commodity shift AND the deleveraging in the markets, what’s the best position to take? More on that tomorrow.
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From the Archives…
Is the Australian Economy… Booming…or Busting?
2012-05-11 – Greg Canavan
The Art of Value Investing: How to Value a Business, Not a Stock
2012-05-10 – Greg Canavan
When Financial Markets Decouple From Reality
2012-05-09 – Dan Denning
Low Interest Rates Are A Dangerous Addiction!
2012-05-08 – Satyajit Das
The Bear Hunters and the Trigger Event for the Aussie Dollar
2012-04-07 – Dan Denning