China’s Collapse
This is my second article on this industry. My initial approach served as an introduction, sharing my thoughts and tips for understanding and gaining confidence in evaluating these specific companies. Now, having outlined the criteria I use for evaluating mining companies, I aim to provide insights into my near-term expectations and projections.
Presently, the broader market doesn't seem to share my enthusiasm for commodities and related sectors. For instance, aluminum, copper, and silver have each experienced declines of more than 20% (some even more) since their peaks at the end of 2021 and early 2022. As discussed in a previous article, miners are highly sensitive to price fluctuations, directly impacting their earnings and overall performance (something to closely monitor).
Let me first address the parallels between historical events and our current situation. From 2012 to 2016, China underwent a gradual slowdown. Initially, it appeared as a growing state, albeit at a slower pace. However, by 2015, the situation deteriorated following government intervention in the stock market (a noteworthy historical reference). The repercussions of these actions had a negative impact not only on the local economy but also reverberated globally.
Here's some data to support these observations (all links are provided below).
The negative sentiment extended to non-Chinese residents, following a similar trajectory to the turbulence experienced during 2015-2016.
This significant Asian country has had an impact on global economic growth, both in the early 2010s and at present, particularly affecting Asian economies. However, this impact has not been as significant for developed countries such as the USA, UK, Eurozone, and Australia.
In contrast, the mining industry has been hit hard, primarily due to China's status as a major importer of natural resources, including aluminum, copper, and steel. The extreme demand for these resources has left some miners with the largest exposure and a high dependence on China's level of consumption. Consequently, any uncertainty in the Chinese economy directly affects their performance.
Other producers were indirectly affected by China's economic slowdown through fluctuations in commodity prices. Aluminium, silver, and copper have experienced losses of between 30 and 40 percent from 2012 to 2016.
You might be wondering: Why has the author provided so much information about China's economic slowdown? Can you see any similarities between the current situation and the years 2015-2016?
Consider the banking crisis of 2015 and the real estate market collapse in 2023. The gradual economic slowdown mentioned earlier, is it referring to 2015 or 2023? Both instances saw a significant decline in commodity prices.
Historically, a similar pattern occurred before and after a downturn, with a subsequent rebound. I'm not suggesting that you should rush to buy mining companies. Instead, I recommend monitoring the dynamics of China's economy.
As Mark Twain once said, "History does not repeat, but it rhymes." Today, mainstream business media are highlighting China's economic challenges and the substantial risk associated with the real estate market.
And that how it was back to 2015-2016:
The sensational headlines are numerous. I've shared just a few that have left an impression on me. Despite my distrust, there's always an element of truth behind the panic they generate. So, let's discuss the risks China is currently facing.
Across most of the world, there is a prevalent struggle against inflationary pressures. However, the situation in China presents a stark contrast. The country's stringent COVID-zero policy and strict restrictions have led to a slow, stagnant consumer demand and spending.
In an attempt to prevent further decline, the Chinese government abandoned this policy and opened its borders. However, the response did not align with the anticipated outcome the government wanted.
Several critical points to bear’s scenario:
The Composition of China's GDP
Roughly 53% of China's GDP is derived from the service sector, a pattern quite common in developed countries. From this standpoint, it's evident that China heavily relies on the service sector, and any volatility or decline in that market will invariably impact the overall economy.
Since reaching highs in March 2023 (57), the service Purchasing Managers' Index (PMI) has hovered near contraction territory. The industrial sector, the second-largest contributor, accounts for 33% of China's GDP. It too remains close to contraction levels.
China's economy had been heavily reliant on a thriving real estate sector, driven by population growth. The housing market not only generated employment but also served as a wealth storage avenue for China's expanding middle class. Local governments relied on revenue from land sales. However, due to COVID-19 and a slower population growth rate, private property developers are facing challenges.
The "Real Estate Crisis," commonly referred to as the collapse of property developers, began three years ago when it was merely a set of issues. It went largely unnoticed by global media due to record housing sales, while two major players were experiencing substantial growth.
Evergrande, the second-largest property developer in China, has seen its stocks plummet by 99% since the highs of 2020, dealing with an enormous accumulation of debt.
The liabilities disclosed in Hong Kong dollars, upon conversion to US dollars, amount to approximately $290 billion in current liabilities. Additionally, the net debt (calculated as current assets minus current liabilities) stands at a negative value of approximately $100 billion. This figure indicates that if the company's management were compelled to pay off the current debt, even after selling off the most liquid assets, they would still owe creditors around $100 billion.
Country Garden, another major property developer in China, is confronted with a similar debt challenge, owing approximately $190 billion.
Risk Linked to Real Estate Collapse:
Numerous commercial banks have significant exposure to private developers and the real estate market, with nearly 40% of all bank loans being property-related, according to the New York Times. However, this finding is twofold, which I will elaborate on later.
As some private developers have defaulted on international debt payments, lenders have begun tightening credit standards. This phenomenon triggers a chain reaction: Banks hesitant to lend cash -> result in cash becoming more expensive -> This, in turn, causes many companies to struggle as they face challenges in securing funding -> leading to a credit crunch. Initially, this crunch affects weaker companies, eventually impacting stronger ones as well.
Something that I found interesting and shows how china is important for global commodity markets:
While it's essential to note that there are various factors affecting copper prices (at first hope as market sentiments on rate hikes(they were thinking about pause) and at second hope as AI-Mania), China remains a primary driver due to its status as the largest consumer of this commodity.
As of the time of writing, China reduced its five year loan prime rate by 10 basis points. While the reduction might not be substantial, it does contribute to a slight relaxation in financial conditions.
Additionally, China's central bank decreased the Reverse Ratio Requirements (RRR) for banks by 25 basis points, which, as per economic literature, should encourage banks to be more inclined to lend.
For example, the People's Bank of China (PBOC) - the central bank in China, conducted reverse repurchase agreements:
The People’s Bank of China injected a net total of 733 billion yuan ($100 billion) of cash into the banking system using reverse repurchase contracts on Friday, as reported by the Daily Maverick . This marks the most significant injection of short-term liquidity into the system since 2020.
Of notable significance is the visit of Xi Jinping to the People's Bank of China, which marks his first visit since his election. This event could be crucial in understanding the structure risk within the financial system.
If not limited to two companies, the consequences could have significantly impacted the big banks deeply entrenched in the real estate market. However, it's reasonable to assume that the Chinese government, holding substantial equity stakes in most major commercial banks, ensures a measure of control over the banking sector. While this might mitigate the likelihood of a sector-wide collapse, it doesn't necessarily mean that credit standards won't tighten in response to external shocks.
From this perspective, it's evident that the government prioritizes the local economy by implementing measures through monetary policy and interventions to cushion against deflation and address decreasing consumer demand.
In concluding my article, I'd like to mention that sometimes the risks highlighted by mainstream media and other influential voices might overshadow the complete scenario. While it's crucial to stay informed about China's challenges and risks, I believe it's equally essential to consider the positive aspects and signals amidst these challenges. Simultaneously, it's prudent to remain aware of the risks associated with a potential downturn, even when the media and society are emphasizing a positive narrative.