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Don’t Get Burned By China
01/11/2012 11:15 am EST
There are still good opportunities in the industries that China has driven up in recent years, as long as you don’t bet only on the Red Dragon’s economy, says Michael Tian.
Michael, we’ve seen a lot of talk about the growth in China slowing down. But even if it slowed down, it’s growth that we here in the US would envy. What’s going on?
I would guess I’m probably, personally, in the China bear camp. Being a Chinese person, and having many, many Chinese family members, I can say that there is a lot of I would say unnatural things happening over there.
For example, there are just a lot of members in my family, they make well less than US$2,000 per month—probably closer to $1,000 if anything—and they’re buying second homes, and each home is worth more than the average home in Chicago. You have places where they’re putting all their savings into buying these houses and they’re getting a 2% rental yield.
Now, who knows where the rest of the down payment is coming from? They could be tapping black-market channels to get a piece of the funding.
I just feel like—and also, I’ve been to China in the past, I’ve seen these ghost cities there. I mean, they’re just empty…gigantic, empty buildings, empty streets, everything empty, kind of falling slowly in disrepair. And having observed these things first hand, I’m very, very nervous about the trajectory of the Chinese economy.
But there still seems to be a big demand for basic materials there.
That’s right. I mean, basic materials has been a huge bull sector for the past decade, and a lot of that can be laid at the feet of China. For example, things like cement, steel, copper, zinc, any of the basic industrial metals and metallurgical coal is another piece of that.
China accounts for just a high percentage of world demand, and that’s caused the prices to run tremendously in the past decade.
But going forward, if their infrastructure demand slows down, if the government is successful in tapping down inflation by tightening monetary policies, I see a lot of room for downside for these commodities and for the companies associated with them.
So would you stay away from the companies such as Baker Hughes (BHI), which is a big China play right now?
I would say that oil is probably one of the exceptions to the rule of China, because I mean there is a very powerful long-term thesis in that oil is becoming harder to find and extract. That’s much less of a China story than just every where else in the world, even though China obviously is an important part of incremental oil demand.
I mean, like I like Baker Hughes, it’s one of my favorite companies in the space right now, because I think their technical know-how will be critical into getting new supplies of oil. Not only to fund China’s growth, but places like India or Brazil or Russia, or even the United States or Europe—anywhere else for that matter.
How about the coal market, that’s also something big in China. Do you have a play there?
Yeah, I mean I’m really, really scared of metallurgical coal, because that’s used for steelmaking and China is 50% of the steel market.
I think it’s a different story for thermal coal, coal that is used to generate electricity. There is a shortage of thermal coal worldwide. Even if China’s infrastructure spending were to slow down, I think it would be much less harmful for thermal coal as opposed to metallurgical coals.
My favorite company right there is a company called Cloud Peak Energy (CLD), which right now is actually more of a United States play, so it’s not directly exposed to China. Almost all of this coal has been sold in the US, to electric utilities, and it’s a very stable market.
In the long run, if you can export coal to China—because there is a tremendous shortage there…each ton of coal exported to China is four times as profitable as a one of coal that sells to the United States. In the very long run I think there is a lot of scope to shift coal supplies to the Pacific Basin. So not only China, but places like India, Indonesia, and other fast-growing markets as well.
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