China’s ‘DOW’ is down 30%...and n o one cares

Thursday, 16 September 2021 — Albert Park

[6 min read]

US stocks rose overnight, with all three major indices rising between 0.7% and 0.85%.

US crude oil was the big mover, up 3%. That’s largely thanks to hurricane season causing havoc in the Gulf of Mexico. As a result, the energy sector was the best performer in the S&P 500.

But the action right now is not in the US…it’s in China. I wrote about this last week. I mentioned Chinese property developer Evergrande and its looming default.

This week, you’ve got more evidence that the stresses in property markets are not isolated events. Based on data released yesterday, China’s economy is slowing sharply. From The Wall Street Journal:

‘Retail sales, a key gauge of China’s consumption, rose just 2.5% in August from a year earlier, down sharply from July’s 8.5% year-over-year growth, according to data released Wednesday by China’s National Bureau of Statistics. The result marked the lowest pace of growth in a year and missed by a large margin the 6.3% increase expected by economists polled by The Wall Street Journal.

‘Separate data released Wednesday by the statistics bureau showed home sales by value falling 19.7% in August from a year ago, the largest drop since April 2020—at the height of the pandemic.

‘Real-estate investment in the first eight months of the year, meantime, increased 10.9% year over year, slowing from a 12.7% gain in the January-July period. Construction starts, as measured by floor area, dropped 3.2% in the January-August period, accelerating from a 0.9% year-over-year decline in the first seven months of the year.’

There are a few things going on here. China was the first to recover from the effects of COVID…and now it’s the first economy to show visible signs of slowing. As in slowing a little too sharply.

You can see this most obviously in the price of iron ore. Since the May peak, it’s fallen around 50%. BHP’s share price is off 26% from its peak, Rio is down around 23%, while Fortescue has declined 33%.

In my view, there is a lot more pain to come in the years ahead. For once, I think the government is right. They are budgeting for US$55 iron ore prices next year. Given the price is still around US$120, that’s falls of more than 50% still to come.

The problem for Australia is that at the same time as Chinese demand weakens via reduced activity in the property sector (and curbs on steel output), Brazil’s Vale is coming back into the market. By the end of 2022, it plans to produce 400 million tonnes per annum, up from 300 million tonnes over the past few years.

Before the tailings dam disaster in January 2019, Vale was the world’s largest producer, at 385 million tonnes per annum.

The short story is that iron ore prices are going back to where they came from.

We’ve seen this play out before. The first iron ore boom coincided with China’s first big property development boom, which got underway after 2008.

As things started getting out of control, China tapped the breaks and ushered in a long bear market. From the February 2013 peak to the late 2015 low, iron ore prices fell a whopping 75%.

Expect something similar to play out this time around. Sure, there will be rallies from time to time (like when iron ore went from a low of US$110 in May 2013 to a peak of nearly US$140 in December), but over the next few years I expect the trend will be down.

On the demand side, China simply cannot afford to keep building property that no one wants. A twitter account called ‘The Last Bear Standing’ has followed the Evergrande story for some time now. Whether they’re right or not in their conclusions, I don’t know.

But they do post some good data on the problems in the sector.

A recent thread suggested that these property developers are hiding losses via a build up of ‘inventories’. A tweet reads:

‘Inventory includes land bank, work in progress construction and completed inventory. While we can quibble about how much of this is “legitimate”, In EG's case, the value of their inventory has proved to be zero. Recent reporting says land sale value is down 96% YoY in Sep.’

Evergrande has around US$220 billion in ‘inventory’. As it cannot monetise this inventory, the stated valuation is clearly incorrect. At what price this inventory would clear is uncertain. But what is certain is that it would reveal a company with current liabilities well in excess of current assets (inventory is a current asset on the balance sheet).

That is, it would reveal a company in bankruptcy.

It’s not just Evergrande either. This is a potential problem for many companies in the sector.

What’s interesting so far is that broader global markets haven’t worried about this too much.

Nor has China’s Shanghai Composite Index. It’s back near multiyear highs. Concerns over a regulatory crackdown (of which property is just one sector) seem to have disappeared. Or at least, there are no worries about contagion.

The Shanghai Composite represents around 1,500 companies. Perhaps you could say that it’s more a reflection of China’s broader domestic economy.

The regulatory crackdown, on the other hand, appears to be aimed at keeping Big Tech companies in check and stopping property developers from destabilising the housing market.

But the Hang Seng China Enterprises Index gives you a much better view of the damage caused by China’s regulatory crackdown. This is the old ‘H-Share’ Index, where Chinese companies listed in Hong Kong to get access to foreign capital.

The index contains 50 stocks, representing China’s tech stocks, banks, insurance companies, and property developers. It’s like China’s DOW. And as you can see below, it doesn’t look at all healthy. In fact, prices are approaching the March 2020 panic lows:

After peaking in March, it’s down a whopping 30%.

So far, the rest of the world is treating this is an isolated event.

The question is, for how long?

Regards,

Greg Canavan,
Editor, The Rum Rebellion

This week, we’re exploring the idea of ‘truth’.

What about crypto?

What is true about it? What is false?

At first, cryptos were thought to be new forms of money. Then, they were ‘assets’, a whole new ‘asset class’ that was making people rich.

And now the crypto riches are spilling out into the real world of houses, yachts, weddings, and college.

Our advice to the crypto millionaires, to be followed by a more careful look: Get out while the gettin’s good.

Always discovering

If we only had access to GUACT (God’s ultimate, absolute, and complete truth!).

Then we wouldn’t have to wonder. And we wouldn’t have to wait for free markets, free thinkers, and free people to pass judgment.

Markets never know anything. They just stumble along…discovering…always discovering. And they never ‘set’ prices.

Instead, thousands, millions of bidders and askers come together…one sells, one buys…together they come to terms at a price that ‘clears the market’.

Will prices go up from there? Will they go down?

No one knows.

National rip-off

The SEC apparently believes so strongly in free markets that they’ve made it illegal to grift them, one way or another. Try to rig prices and you go to jail.

And yet, the biggest manipulators in the nation got away with it for years. And when the cat got out of the bag, the press barely mentioned it.

A small item in the weekend Financial Times:

‘Two Federal Reserve officials said they would sell their portfolios of shares by the end of the month after coming under scrutiny for investing and trading in a year when the US central bank took extraordinary steps to shore up financial market.

‘Robert Kaplan and Eric Rosengren, presidents of the Dallas and Boston Feds respectively, confirmed that they would hold the proceeds from the share sales in cash or invest them in diversified indexed funds…’

No institution has more effect on stock prices than the Fed.

Apparently, Fed governors made millions trading on their insider knowledge. Will they be prosecuted? Investigated? Shamed?

Not likely. The elite look out for their own.

They call out football teams for using ‘Native American’ names…and the University of Texas for a fight song that they think is ‘insensitive’.

But rip-off the whole nation for millions of dollars? Who cares?

Were it not for Fed support, stocks might be selling for only half of today’s prices.

But it’s cryptos we’re looking at today. What has the Fed done for them lately?

More precisely, is the runaway crypto market the sign of a dynamic new industry — like autos in the 1920s — just taking shape? Or is it just another feature of the Fed’s bubble?

To the Moon

Cryptocurrency was a new idea in the early 2000s. An off-the-wall idea that few people understood…made popular by a man nobody ever met — Satoshi Nakamoto.

And then…cryptos went ‘to the Moon’.

People dropped out of school to buy them, sell them, create them…and get rich on them.

At first, they were just playing with each other. But as more and more players came into the casino, the chips rose in price. Satoshi became famous.

And as the piles of chips grew taller, people began to wonder how they would be cashed in.

The Wall Street Journal answered that question on Monday…‘Bitcoin to Bucks: Crypto Fans Borrow to Buy Homes, Cars — and More Crypto’:

‘Crypto enthusiasts…are tapping their holdings to buy homes, cars and, often, more crypto. They are getting these loans from upstart nonbank lenders and automated, blockchain-based platforms.

‘Like banks, these lenders typically take deposits. Unlike banks, their deposits take the form of crypto. The crypto deposits — which earn higher-than-average interest rates — are used to fund loans toborrowers who pledge crypto as collateral.

‘These loans take many forms. Borrowers can get dollars or other traditional currencies, or stablecoins pegged to them, depending on the lender they are working with.

‘The business is growing rapidly. One group of crypto lenders has $25 billion in loans outstanding to individual and institutional clients, up from $1.4 billion a year ago, according to the crypto research firm Messari.’

One of the lenders advertises a 6% interest rate to anyone who will deposit bitcoin. And yet…normal banks only pay about 1%.

What gives? Is this a whole alternative financial universe with its own rules and its own rates? Or what?

With cryptos, as with everything else in the world — from a woman’s smile to a drone attack — there’s always more to the story.

We’ll look at more of it tomorrow.

Regards,

Bill Bonner,
For The Rum Rebellion