A lot of (virtual) ink has been used to discuss the economic situation in China at great lengths, and most opinions voiced concerns about the reduced growth rate in the country. Here at Secular Investor we were always a bit reluctant to accept that type of reasoning as what would make the Chinese economy crumble because after all, the GDP continues to grow at a 6-7% rate on an annual basis.
On top of that, you just know the Chinese government will try its best to save face and avoid any remarkable slowdown, and we feel the Chinese president and prime minister would also use Super-Mario Draghi’s catch phrase ‘whatever it takes’.
The market now seems to be catching up on that as well, as China has been removed from the forefront since it devalued its currency, almost exactly a year ago. Even though the impact of the devaluation initially remained very limited with a 3% difference in one week (from an USD/CNY exchange rate of 6.20 to 6.40), the Chinese Yuan continued to weaken and as of right now, you receive approximately 6.65 Yuan per American Dollar you’d convert. This means China’s currency has now become 7.26% cheaper (which is twice as much compared to the initial ‘official’ devaluation), and this doesn’t seem to upset the market as much as the initial 3% move.
Does this mean there’s no slowdown? No, not at all, as all data are still pointing in the direction of a lower growth rate. We will very likely never see the double-digit GDP growth (again), but we also shouldn’t overestimate the impact of the slowdown as everything seems to be very gradual. After a GDP growth of 7.7% in 2013, 7.3% in 2014 and 6.8% in 2015, the economy is expected to expand at a rate of 6.2-6.7% this year. Yes, that’s a lower growth rate, but if you can continue to grow your economy at a rate of in excess of 6% per year, you’re still putting in a very nice performance!
Cracking down on shadow banking has done the economy pretty well, but this also meant the base metals prices were hit pretty hard, as for instance copper played an important role in the shadow banking system.
Source: Financial Times
The system was pretty simple, and some sources estimated up to half of China’s copper warehouse inventory was used in the shadow banking system. As a lot of these trades were unwound (either voluntarily or being forced by margin calls), the copper price experienced some pressure on its price, as you can see in the next image.
Source: Stockcharts.com
Now the impact of the shadow banking system on the overall health of the Chinese economy has been reduced, we wouldn’t be surprised to see the ‘real’ demand for copper picking up again in the near future, as the end-users of the copper have been drawing down from their stockpiles in the past few quarters and years.
We saw the exact same thing happen with the iron ore price, where a sudden supply glut killed the prices (and the operating margins), but the situation now seems to have been stabilized, and the iron ore price is now trading in the low-60’s range once again (after having traded as low as $40/t just eight months ago).
Source: Vale website
If our theory proves to be right, we are expecting a higher copper price in the not so distant future on the back of an increased demand for seaborne copper from China. China isn’t dead at all, it just took a temporary pause.
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