China, the proxy trades: commodity companies?

June 26, 2012 § Leave a comment

From Simon Hunt commentary (my highlights):

“Some Chinese importers are facing fixed price contracts negotiated at higher levels whilst all are experiencing weaker domestic demand. At the same time banks have become much more cautious in extending loans and opening up LCs since they are looking closely at their customers’ collateral. Moreover, steel traders and iron and coal importers have been using their inventories as a mortgage for loans and have been round tripping the banks. Banks have incurred very large losses on this business which has added to their caution in lending to this group. This is why many importers of coal and iron ore are defaulting on their contracts, as we wrote yesterday. We hear that there are some 30 cape sized vessels moored outside Chinese southern ports unable to unload their cargoes because of the situation set out above.

What we are trying to discover is whether this is just an industry specific problem or whether there is a far broader issue and with it a more significant change. It is this. Over the past six years or so, excepting 2008 and 2009, China’s growth rate has been robust and has been highly geared to heavy industry. The country – and its companies – could absorb the sharp increase in imported raw material prices. Now the economic model is changing. The economy will be less dependent on heavy industry; margins are under severe pressure; the cost of money will be determined increasingly by market forces; and this will mean that domestic players, whether institutions or individuals, will be exiting speculation in commodity futures. This will be the trend. But, the point is that China cannot now afford to pay for imported raw material prices that are so excessively priced and which Beijing senses have been rigged.

As we have concluded, banks are getting increasingly cautious in lending against the importation of raw materials. Is this the first stage of China trying to burst the commodity bubble?  Eventually, the bust will come either by market forces relating to a trend slowdown in economic activity in China together with a change in the mix of business or by a combination of such a slowdown together with government action. What is now being experienced is bank caution in China which will have global implications. ”


Who will be the big loser? highly leveraged commodity companies??


From Bronte Capital (again my highlights):


“For an Australian investor (or an investor in the large Australian mining stocks) the (literally) sixty four billion dollar question is what is the normalized profit of iron ore companies? At the moment (in what might be the tail-end of a wild boom) the profit situation reflects two things (i) an historically very high iron ore price and (ii) historically high costs (especially labour) incurred to get the stuff out of the ground.”


Fortescue [An Australian iron ore company. Fortescue is the fourth largest Iron ore producer in the world as of March 2011.] chief executive Nev Power interview with Alan Kohler:


“ALAN KOHLER: But what matters to you of course is the iron ore price.


ALAN KOHLER: What price have you got in your forward planning, in your budgeting?

NEV POWER: Well, we see in the short term that it’ll trade in that range of $130-$150 a tonne and it has been very resilient over the last 12 months or so trading around that range. But looking forward we’ve allowed the forecast to drop down to around $110 a tonne and done all our modelling around that, so we see that long term that’ll be the sustainable price.

ALAN KOHLER: But in the 2008 crisis it got down to as low as $55 a tonne, so if there’s another crisis – this is what I’m talking about you feeling a bit nervous – if there’s another crisis, Spain collapsing, Greece or whatever, you could see the price go down to that level again.

NEV POWER: Well, Alan, it did go down to around a little under $60 a tonne but that was for a fleeting moment and it recovered to over $100 a tonne within weeks – and that was a global financial crisis, that was a real global crisis.

ALAN KOHLER: But the reason it recovered so quickly the Chinese economy recovered so quickly and right now it’s slowing.

NEV POWER: Well Alan, the Chinese economy is going through a short-term fluctuation, but overall it’s growing very strongly. It’s growing in that 7 to 8 per cent range which reflects back to a 4 to 5 per cent growth in steel which we see as a really strong growth and something I think a lot of countries would aspire to.”


A “short-term fluctuation”…



Chinese hard landing coming…

June 25, 2012 § Leave a comment

I spoke with someone in the investment game in late 2011, and they made the following comment on China:

“roughly 50% of Chinese GDP is derived from investment (housing, roads, railways etc.)

Of that investment, I think its fair to say probably 20% is pure waste. Houses that lie empty where they’re not needed, shoddily built railways etc…

…so that implies roughly 10% of GDP in China recently is fiction.

In other words, China has no ‘real’ growth in the past few years”


following up on this thesis is David McWilliams view:

The tricky problem for China is that a faltering investment boom – unlike a faltering consumption boom – can’t be easily reversed by cutting interest rates. If the problem is over-capacity, building more in response to lower interest rates will only produce more capacity, exacerbating the original problem.”


What I need now are economic, price, inventory and other data series to back up this view.

And in tandem I need a series of trades that will capitalise if the thesis is correct…


On the question of what trade…

“China trades are all about the proxies not the underlying, look at countries with relative terms of trades changes towards China, and the rate that change recently etc   trading cny instruments is waste of time and usual terrible populated as range of access products is so restricted everyone ends up in same trade CNY 12m or some HK equity play etc and can’t get out”


to be continued…