Sunday, September 25, 2011

Bearish China Bets: Base Metals, Mining Companies, and Casinos

The slow motion collapse of the Economic and Monetary Union of the EU (and possibly - hopefully - collapse of the EU itself) is monopolizing investor and media attention, with the result that nobody is talking about the situation in China.

A friend of the blog calls our attention to the deterioration in the Chinese stock market, with the FTSE China 25 index dropping to the lowest level since May 2009! Even worse, some of the financial company stocks in the China 25 have dropped below their 2008-2009 lows, for example the China Life Insurance Company (which is 4% of the index) and also Huaneng Power. The other China alarm bell that is going off is the price of copper, which has absolutely cratered over the past two weeks.

As I have written before, I am in the bearish on China, Jim Chanos camp. A few key facts about the fixed asset investment bubble in China:

  • 25 of the top 50 skyscrapers in China (not including Hong Kong and Macau) were built with investments from the property sector, unlike most of the top 50 US skyscrapers, which are used as company headquarters.
  • China had over 200 skyscrapers under construction in 2011, a number equal to the total number of U.S. skyscrapers.
  • Dubai, at the peak of its building boom, had 240 square meters of property under development for every $1 million in national GDP. In urban China today that ratio is four times as high.
Related to the malinvestment in China is the broken Chinese economic and political system that I wrote about in my review of The Party: The Secret World of China's Communist Rulers. Their entire system is at cross purposes with the carefully considered positive ROI projects that are needed to actually create wealth.

There are three good ways to bet on a collapsing China bubble: short commodities and particularly base metals, short base metal miners, and short the U.S. companies that have made huge bets that Chinese consumers are as stupid as U.S. consumers (think casino stocks).

The reason to be short base metals is that they are not only used in fixed asset construction, but also because the Chinese have built up enormous stockpiles of them.This recent WSJ article shows the number of weeks of inventory for Al, Zn, and Pb, and the first two look very high going into another worldwide recession. Don't forget that Chinese economic data like metals inventories is unreliable and probably biased downwards. One good base metal short play would be the PowerShares DB Base Metals Fund, which has listed options. Another choice would be the Dow Jones-UBS Industrial Metals Subindex which has copper.

With miners, there would be a number of choices: Global X Copper Miners ETF, the Dow Jones Emerging Markets Metals & Mining Titans, and the SPDR S&P Metals and Mining ETF.

I like betting against China and commodities because there are actually U.S. energy related values that I want to own, but which need to be hedged. There are the resource company converts that I have written about, and this weekend I am finding exploration and production straight debt yielding 10%+ with debt/proved resources less than $1/mcf!


Joe Nelson said...

The crash in China is going to be epic. The ghost cities, the reverse merger scams, the bridges to nowhere; all signs of a giant easy money bubble. All the talk I've been reading about a "soft landing" is nonsense. What is going to be very interesting is how the government reacts.

Brazil doesn't look too good either and unlike China, Brazilians have US-like levels of personal debt, too.

CP said...


Tell us more. Have you heard about the Chinese officials and businessmen fleeing? What is really going on over there?

Joe Nelson said...


Here's a good one:

The credit markets appear to be in the early stages of a freeze. The PBoC took a tight money stance last fall in order to combat the rampant price inflation and I think we're starting to see the effects of this policy. I expect many businesses, like the ones referenced in the article, to find themselves without access to cheap capital and unable to pay back their loans at which point the banking sector in China is going to be significantly impaired.

CP said...

Wow! Where are they going? To Irvine, right?

Looks like copper is going to get flushed! The 2008 low was a buck.

Joe Nelson said...

I hear they like Vancouver.

Also, here's what you get with your purchase of a few billion in Euro denominated sovereign debt:

China Is World’s ‘Most Crowded’ Short, Societe Generale Says

CP said...

divergence between base metals and FXI

Base metals need to fall to close the gap.