Why They Should Learn Mandarin in Australia

by Ivan Martchev | June 7, 2012 6:45 am

Chinese GDP has grown from $3.49 trillion in 2007 to an estimated $7.99 trillion for 2012. As the second-largest economy in the world, China clearly has a massive and growing impact on its trading partners.

While China is vilified in the West as a predatory exporter, major economies in the region such as Australia and South Korea run large trade surpluses with the country and count it as their biggest export market. Australia is the most intriguing in this case, as the growth in trade with China has been truly staggering.

In the past five years as the Chinese economy has more than doubled in GDP, Australian exports have more than tripled to A$71.56 billion at the end of 2011 (the Australian dollar is worth about 99 cents at the time of this writing). Australia used to run a trade deficit with China similar to many Western countries, but five years ago, exports to China literally went parabolic and surpassed imports, which now stand at A$42.14 billion.

What is more important is that exports keep growing much faster than imports — 22.5% vs. 7.4% growth for 2011 — which is causing the trade surplus to widen notably. Given that the size of the Australian economy was A$853 billion at the end of 2011, total trade with China (imports plus exports) has reached a staggering 13.5% of its GDP.

So what are the Chinese after “down under” that they can’t get anywhere else?

Hard commodities would be a good way to describe it. Iron ores & concentrates (A$44.05 billion), coal (A$4.54 billion), crude petroleum (A$2.90 billion) and wool & other (A$2.02 billion) are the big export categories. Australia is supplying the Chinese infrastructure and industrialization boom as the bulk of trade is concentrated heavily on metals and some energy commodities.

This supersonic growth in trade has turned China and Australia into economic Siamese twins, where Chinese economic developments affect Australia more than any other country. The relationship is not as close to that of Canada and the U.S. — 73.7% of Canadian exports go the U.S., while 49.6% of its imports come from there — but given how fast Aussie-Sino trade is growing, it likely is headed to a similar level of trade entanglement.

That explains the present worry in the stock market that a Chinese economic slowdown — (almost) no one dares to call for a Chinese recession given how well it sailed through the 2008-09 financial crisis — will rub off negatively on Australia via the large trade connection.

Chinese loan growth numbers have been coming in on the weak side, and they are a reliable indicator of economic growth. New bank loans last month dropped 33% from March to 681.8 billion yuan, missing the 780 billion yuan median estimate. Such notable a decline in lending in April (though May perked up to 800 billion yuan) means it’s likely the banks’ total new loans for 2012 will be about 7 trillion yuan ($1.1 trillion), missing the government goal of 8 trillion yuan to 8.5 trillion yuan. The decline in lending has come from demand for new loans and not tightened lending standards as the Chinese government has an unusually firm grip on the banking system giving it great power over the Chinese economy.

What are the implications of all this for Australian investments available to U.S. investors? The more commodity prices correct because of the Chinese slowdown and any European escalation, the lower the Australian dollar is likely to go as the trade surplus with China is likely to narrow sharply because of the falling value of exports.

Luckily, iron ore and coal are traded in longer-term forward contracts compared with the real-time pricing of crude oil futures so there will be a delay, but the currency markets will not wait for such a confirmation. In 2008, the Australian dollar went from 99 to 60 U.S. cents in a couple of short months as the markets anticipated a bigger Australian economic slowdown than it actually occurred given the resilience of the Chinese economy at the time. The Australian dollar is tradable via the Currency Shares Australian Dollar Trust (NYSE:FXA[1]), where options are available.

The coming correction in Australian equities might prove quite the buying opportunity for long-term investors interested in China investing proxies in more friendly jurisdictions. (One problem with many Chinese equities is that many companies in the country are not run for the benefit of shareholders, but for the benefit of social stability. This is why a developed market like Australia may offer superior ways to play China.)

The MSCI Australia Index Fund (NYSE:EWA[2]) is an index product[3] for long-term exposure to the Australian economy that is 45% weighted in financial and 24% in material stocks. The large financial sector weighting in the ETF gives leveraged exposure to the rising influence of the China over Australian economic growth.

The large international mining conglomerates that trace their roots to Australia — Rio Tinto (NYSE:RIO[4]) and BHP Billiton (NYSE:BHP[5]) — also are more targeted ways to play the intensifying Aussie-Sino trade entanglement centered on iron ore. Rio holds 23% of global seaborne iron ore trade (Australia in total holds 41%). BHP has the better part of the rest of Australian iron ore output, but it also has major operations in Brazil in partnership with Vale (NYSE:VALE[6]).

The above three players are the heavy hitters in the iron ore market, where the macro winds are shifting in favor of those with Australian operations as output there is growing faster — estimated to rise to 50% of seaborne trade — thanks to less stringent mining regulations and closer proximity to China.

Whether Aussies like it or not, the increasing influence of China over their economy has made their country a leveraged proxy for Chinese economic growth — on both sides of the market.

Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds a position in BHP Billiton and Rio Tinto for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the aforementioned securities.

Endnotes:
  1. FXA: http://studio-5.financialcontent.com/investplace/quote?Symbol=FXA
  2. EWA: http://studio-5.financialcontent.com/investplace/quote?Symbol=EWA
  3. index product: http://us.ishares.com/product_info/fund/overview/EWA.htm
  4. RIO: http://studio-5.financialcontent.com/investplace/quote?Symbol=RIO
  5. BHP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BHP
  6. VALE: http://studio-5.financialcontent.com/investplace/quote?Symbol=VALE

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