The world’s financial markets are responding to the “global Goldilocks” scenario, and one of the big winners has been copper. But I’d be careful about jumping aboard, because copper is heavily tied to the China story. In fact, the China story IS the copper story. As long as the latest China story holds, copper prices should continue to rise, but many aspects of that narrative could change on a dime.
Monday, the ISM manufacturing index for July and construction spending for June beat expectations. But who cares about that? Did anyone in Europe or China even think about those numbers yesterday? I know they were announced at 10 a.m., after all the excitement had already hit the market. But the world seems to be less concerned about the U.S. economy than ever, and Monday’s action was proof.
Uncle Sam sneezes and nobody says “bless you” anymore!
They used to say that when the United States sneezes, the world catches a cold. But it seems the tables have officially turned.
Financial markets have been focused on fear about Europe imploding or China overheating. Yesterday, those fears were put to rest, at least for this month. But as the markets go, we’ve been hearing very different stories and forecasts with each quarter that passes, and my feeling is that the changes in the global economic story will swing back to negative in no time.
So, Europe Isn’t Imploding?
I’m not ready to buy this story, although the market sure seems ready.
Of course, we recently got positive results on those super reliable, highly trusted bank stress tests (kidding). Monday, BNP Paribas reported a 31% surge in second-quarter profits, beating market expectations. HSBC Holdings plc (NYSE: HBC), Europe’s largest bank by market capitalization, reported its first-half net profit more than doubled to $6.76 billion.
Boy, I guess there’s no need to worry about Europe anymore.
I’m not buying the notion that all is well in Europe, because these banks’ reported earnings, in my mind, say little about the health of European banks overall or about the European governments. The problem with the banks is that they own lots of government bonds, and the stress tests didn’t even account for the health of the governments that back those bonds. But I recognize that it’s not whether I agree with the rationale of the market that counts. What matters is what the market thinks.
So, China Isn’t Growing Too Fast?
China hardly seemed to get the memo about the global recession. Instead, economic growth in China accelerated to 11.9% in the first quarter, the fastest pace since 2007, triggered by government-led stimulus and expansive bank lending. But there IS such a thing as growing too fast. If the new 800-pound gorilla overheats, it could have huge effects on the rest of the world.
The fear with the China bubble is the same as all historic bubble-based fear: The China bubble gets too big to manage, too difficult to pop, because the bigger it becomes, the more difficult it is to manage.
Monday, markets rallied because we saw more evidence of China’s growth slowing: A purchasing managers’ index, released by HSBC Holdings Plc and Markit Economics, fell to 49.4 from 50.4 in June. Readings below 50 mean that the sector is expanding, while below 50 indicates a decline. Manufacturing contracted for the first time in 17 months.
The latest economic data lends credence to economists’ recent argument for a “soft landing” scenario that we heard two weeks ago when we saw that China’s second-quarter GDP grew 10.3% year-over-year (below forecasts of 10.5%), slowing from the 11.9% annual growth recorded in the first quarter. China’s government clamped down on property speculation and lending in general, and now that they are seeing their economy slow down, they seem to be keeping a steady hand.
Over the weekend, China’s central bank said it would continue to implement its current “moderately loose” monetary policy. Comments like that ease fears that China might tighten monetary policy too fast for a soft landing.
The comment was key, because markets want to see China sort of “tap the brakes” instead of coming to a screeching halt. If they tighten too fast, it can cause markets to collapse. And if China — the biggest buyer of commodities and the biggest buyer of U.S. debt — runs into serious trouble, that means the rest of the world is in serious trouble. In fact, that scenario may be the biggest threat we all face.
I definitely have to commend China for doing what seems to be (so far) a great job at managing their economy. It’s a very tough task, and as you probably know, the Fed here in the United States is known for over-tightening or over-loosening, and doing both a little too late and for too long. It seems we do too much, too late, so we tend to perpetually fishtail.
It’s a difficult job, and more times than not, economies with bubbles just don’t see soft landings. If China can pull it off, then kudos to them. But I like to bet on high probability outcomes, and the odds of soft landings from asset bubbles are low. And the situation is even more sensitive than investors may think.
China is in a forced tightening position.
Contrary to popular belief, China isn’t exactly ahead of the curve, or tightening on their own terms. They have a cool poker face, but that’s all it is. They don’t want to cause a panic by telling the truth.
Don’t let Monday’s headlines fool you — China’s in a jam. And it’s only a matter of time until investors start to focus again on media reports that 23% of the 7.6 trillion yuan ($1.1 trillion U.S.) that banks lent the local authorities to finance infrastructure could become non-performing. According to New Century Weekly, just 27% of the projects currently are on pace to pay off the loans!
China can, of course, mitigate that risk by requiring borrowers to set aside more capital. But that hardly seems like a realistic answer. If you’re already not bringing in enough cash, then how easy can it be to set aside more capital?
When China takes measures to slow their economy, in this day and age, that actually might mean slowing down global growth. Where do you think commodity prices will go when the house of cards falls in China?
Goldman Sachs Group, Inc. (NYSE: GS) says that 27% of copper demand comes from China. Look at the two charts below from Metal Miner. The fist one shows world copper consumption growth. The second shows world copper consumption growth, excluding China.
Sometimes a picture is worth a thousand words. The pictures above illustrate the reasons why the copper tracking ETF iPath DJ-UBS Copper Total Return Sub-Index ETN (NYSE: JJC) ripped higher on Monday, and has been in rally mode over the last couple of weeks. So the copper story, like many commodity stories, is really a China story.
When you hear about a potential “double dip” recession, just remember that all the pundits that are good enough to give us their opinions are giving you an “all things remaining constant,” plus or minus a couple variables of their choice.
But if China doesn’t successfully cross the economic tight wire, we’ll all be facing problems that most investors haven’t even considered.
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