A Contrarian Look at China's Incredible Rise

A Contrarian Look at China’s Incredible Rise

Pacifica Partners’ Financial Post Weekly Column – Nov 26th 2009


In the last two decades, China has achieved a remarkable economic track record. Millions of its people have been lifted out of poverty, it has left the shackles of Communism far behind while capturing the world’s attention with its potential achievements yet to come.

However, there is a flip side to the Chinese economic miracle that has not been getting any attention – until now. Several years ago, the New York Times detailed how Chinese economic data gets fudged and that perhaps it gets marked up at various levels of government before it is officially released. I asked an observer of Chinese investment markets this question some months after seeing this story, and I was told “Maybe they do but we just have to look at the rising consumption of energy, cement and other metals and realize that it is the real deal”. Marc Faber, a highly regarded market commentator and publisher of the Gloom, Boom & Doom investment publication was quoted that perhaps China is only really growing its economy at about 3% rather than the 8-9% that is officially stated.

China's Economy

Chinese Smoke Stacks – Source: OTC Journal

In recent weeks, there has been an increase in opinions being published that are taking a little more critical look. One of the more in depth analysis was published by Pivot Capital Management. Their work was picked up by famed US short seller James Chanos. (Chanos rose to prominence in the investment business when he figured out Enron was a scam and shorted it all the way to its bankruptcy and followed that up with a very profitable move betting against the US banks).

While China has earned strong admiration for its stimulus program because of its scope and ability to deliver some immediate results (whereas the US stimulus program has only delivered a third of its promised commitments), some are questioning if China is just going to make things worse for itself in the long run. For example, the Chinese steel and aluminum industries are plagued by massive overcapacity and yet the stimulus program has induced more additions to these industries. Chinese steel prices are down 20% since August while Chinese net exports of steel have dropped from over 40 million tons in 2008 to just barely above 3 million this year. Yet, there is still another 58 million tons of steel capacity under construction despite efforts by the government to try to reel these excesses in.

The problem extends to numerous industries beyond steel. The cement industry has an overcapacity of over 300 million tones – more than the total consumption of India, Japan and the United Stated combined. For a North American producer of cement, this must be a statistic that keeps them awake at night.

Chanos has highlighted the fact that Chinese gasoline consumption figures do not match the reported rise in automobile sales. While it cannot be argued that the bicycle is being replaced by the automobile as China’s wealth rises, the discrepancy should serve to caution investors who are aligning their portfolios alongside the commodities boom story. Perhaps things are not what they seem.

With respect to this particular argument, the counter point is made that the discrepancy in the fact that gasoline consumption is not rising with car sales/production is due to the fact that most of the cars being bought are fuel efficient vehicles. If that is the correct rationale for this discrepancy, then what does that do the argument of those that say oil is $75 – $80/barrel currently because of rising consumption in the emerging markets. It would seem that one argument tends to offset the other.

There is also the potential that these problems are starting to extend to the banking industry. This year alone, the country’s banks have extended about $1 trillion of new loans. The markets have become wary of Chinese bank stocks as they have filed for permission to look at the idea of raising more capital through additional share sales.

To read the rest of this article please visit the Financial Post online: FP Magazine Daily

Pacifica Partners are weekly columnists for the Financial Post

Legal Disclaimer

This report is for information purposes only and is neither a solicitation for the purchase of securities nor an offer of securities. The information contained in this report has been compiled from sources we believe to be reliable, however, we make no guarantee, representation or warranty, expressed or implied, as to such information’s accuracy or completeness. All opinions and estimates contained in this report, whether or not our own, are based on assumptions we believe to be reasonable as of the date of the report and are subject to change without notice. Past performance is not indicative of future performance. Please note that, as at the date of this report, our firm may hold positions in some of the companies mentioned.

Copyright (C) 2009 Pacifica Partners Inc. All rights reserved.

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