The China Threat

There are no shortage of worries for investors these days but at the top of the list is China. The following chart illustrates how important China has become for our Gross Domestic Product (GDP):

The Bank of America Merrill-Lynch survey of international fund managers polls large funds with assets under management in excess of $708 billion.  In the latest survey, big funds are seen fleeing emerging market equities, driving down holdings to levels not seen since December 2008.  Thirty two percent of respondents are now underweight commodities and overall investments in raw materials reached an all time low at June 2013.  The biggest threats, according to fund managers, are a collapse in commodities and the potential of a ‘hard landing’ in China.  According to BAML, the market is anticipating a ‘China shock’ in the near future.

Barclays forecasts Chinese GDP averaging 7.4% in 2013 and 2014; a risk of a quarterly fall to 3% in the next three years is possible should Government changes temporarily slow the economy down.

Barclays argues that a 3% scenario would tip Australia into recession. The big risk is how the government responds to the credit bubble, and how they manage to boost domestic consumption.  Although infrastructure projects are continuing in China, the infrastructure boom days are over.

Barclays argues that the risk for Australia is not declining exports to China but declining investment in mining expansion. Australian miners rushed to expand production capacity in the face of rising commodity prices and seemingly limitless demand from China.  While some future expansion plans have been scrapped and projects delayed, the investments in the early days of the resources boom are now coming on line.  In support of Barclay’s observation, BREE increased its 2013 iron ore exports forecast to a rise of 14%, up from its 2012 March forecast of 12%.  The value of these exports will increase by 11% in nominal dollars, as the declining Australian dollar offsets lower commodity prices.

The 2013 BREE China Review was completed in conjunction with the TRA (Tourism Research Australia) and uses some data from the World Bank. The number of Chinese tourists visiting Australia has tripled in the last decade.  According to the ABS (Australian Bureau of Statistics) Chinese tourist visits was 630,000 in 2012, up from 190,000 in 2002.  However, of particular interest to investors is the future of resources and energy.  The following graph taken from the BREE report is the reason why:

Resources and energy share of total export earnings, Australia

In an export-dominated economy, the lion’s share belongs to resources and energy.  Australia’s largest export commodity is iron ore, followed by coal and then gold.  Most expect Chinese steel consumption will peak after 2020.  Economists at Rio Tinto (RIO) predict it peaking in 2025 and BHP Billiton (BHP) sees increasing consumption until 2030.  The 12th Five Year Plan (FYP) adopted by the Chinese government in 2010 calls for additional infrastructure development, albeit smaller in scope, as well as housing construction and renewal in urban areas and increased equipment manufacturing.

The following chart from Bloomberg shows where Chinese steel has been allocated:

Chinese Finished Steel Consumption by End Use to 2011

The World Bank’s forecasts GDP growth of 7% from 2016 to 2021; 5.9% to 2025; and 5% from 2026 to 2030.

Despite introducing free market reforms from 1978, much of China’s economic output continues under the control of State Owned Enterprises (SOE).  Currently the SOE’s control most of China’s telecommunications, banking, and heavy manufacturing sectors.  Clearly, reforming these state run enterprises or privatising some, is keenly demanded by organisations such as the World Bank as well as multinational companies that stand to profit.

Australia’s Big Four banks could benefit if China restructures its banking sector.  ANZ has five branches in China already.  If China reforms its telecommunications sector, ASX listed Singapore Telecom (SGT) could benefit as well.

The “green growth” priority in China could provide opportunities for ASX listed clean energy companies like Silex Systems (SLX), Infigen Energy (IFG), Dyesol Ltd (DYE), Carnegie Wave Energy (CWE), and Ceramic Fuel Cells Ltd (CFU).

Finally, while the growth opportunities for Australia’s iron ore may be peaking, another of our natural resources is likely to benefit handsomely from China’s need for cleaner electricity generation.  That resource is Liquefied Natural Gas and ASX listed companies Woodside Petroleum (WPL), Santos Ltd (STO) and Oil Search Ltd (OSH) are ready and waiting.

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