I recently spent a fascinating week in China. I arrived in the country cautious but left with a renewed sense of comfort about the long-term structural growth story. I also gained some interesting insights into China’s continuing influence on the global commodity markets.
From a macro perspective, there is no doubt that a combination of monetary tightening, commodity price inflation and electricity supply shortages are driving a significant slowdown in Chinese GDP growth.
Credit tightening is also having a serious impact on small and medium-sized companies which will inevitably lead to a growing number of non-performing loans in the banking sector.
Automobile sales are weak on the back of various government measures, housing sales volumes are poor and a weak domestic stockmarket continues to point towards tightening liquidity.
However, all this is consistent with an engineered cyclical slowdown in the pace of growth, designed to control inflationary pressures, rather than a sign of any kind of structural decline as some of the China bears might have you believe.
First a few words on growth.
China’s longer-term growth continues to be driven by demographic dividends, urbanisation and globalisation. HSBC recently published an interesting report (The Southern Silk Road Stephen King, HSBC, June 2011) which put the development of various emerging markets into an historical context by placing them on a timeline of US economic development.
On this basis, China stands approximately where the US was in 1941. What is even more interesting is that China is achieving in a decade what it took the US 50 years to achieve. The rapid pace of innovation and productivity growth was apparent throughout my trip.
Much has been written about the supposed property bubble in China but my view is slightly more nuanced.
Property prices are towards the top end of their rising trend in real terms and the house price to income ratio is high but the strong counter-argument is the total housing stock in China is still short of demand (according to some estimates by almost 80 million units).
Most of the new supply has been at the top end which has been absorbed by investors paying cash instead of using loan financing, leaving a shortage in the middle and at the bottom end of the market. It is as if there has been massive overbuilding in Knightsbridge in London but too little construction outside the M25.
The government, through its social housing initiative, is trying to set this imbalance right and, over time, this will continue to support commodity demand.
Domestic consumption remains a positive driver of demand for some commodities. Copper looks to be a beneficiary, thanks to its importance in, for example, air conditioning and car manufacturing.
China remains committed to innovation and renewable technologies and electric cars, for example, use up to three times as much copper as traditional ones. Cars are largely bought for cash in China and, with fewer than 60 cars per 1,000 people (compared with 750 in the US and an average of 150 in the world), the road for growth stretches very far.
The main insights from my trip can be summed up in several points. First, China’s favourable long-term structural growth path is undiminished. Second,innovation and productivity continue strong and while rising labour inflation is a worry, increased GDP per capita will drive the economy more towards consumption-driven growth. Third, as China moves towards becoming more of a consumption-driven economy and less of a investment-driven one, the outlook for consumption commodities (energy, platinum, potash, oil) should be better than those driven primarily by investment spending (steel, aluminium, iron ore, etc).
From a stockpicker’s perspective, these are encouraging outcomes because they will mean the winners over the next 10 years will be very different from those of the last 10.
Amit Lodha is portfolio manager at Fidelity International