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The China Conundrum

Posted on | October 28, 2008 Time: 12:33 am |

There’s no question that every major economy in the world is reeling; we’re about 2 crucial months behind on the data that will really highlight the extent of the damage caused by the last 45 days’ worth of crisis. All of the 3rd quarter earnings & GDP figures give us just a peek to the end of September, but the fourth quarter is when the rubber will be the proverbial road.

China’s reported third quarter GDP of 9% has been the subject of much debate the past week, as the nation represents the world’s best shot for consumption growth in the coming year. Depending on who you listen to, the 9% figure is either:

a) better than “street estimates” of 8%

b) below consensus estimates of 9.5%

c) patently false and/or useless because of fraud/misinterpretation/poor sampling on the part of the Chinese

Pick a Range, Then Focus on Sectors

China had been running along at 10% or above for most of 2008, so we all expected some drop, it was just a question of how much. My consensus: I don’t know how much I really trust their data, whether it be because of sheer logistical constraints or good ole’ number fudging. Heck, for that matter I don’t know how much I trust our GDP numbers. At the end of the day it’s all about sample sizes and sample strengths…and, I doubt I am alone in my general uncertainty over the analytical prowess of the U.S. government at this moment in history.

So we fight the battles we can, and come up with a number range that nets out what we think and what we know. We know that China is going to slow rapidly at least through the first quarter of next year. There simply aren’t any pockets of economic strength in the world, and China’s manufacturing base exists mainly to supply exports. But I am expecting to see continued strong growth in several sectors, mainly those related to China’s desperate need for infrastructure growth.

They Have the $$ and the Favorable Economics

China has $2 trillion in “rainy day” surpluses, and they need major infrastructure investments before the domestic economy can really flourish. I’m happy with lowballing the GDP number and say that China will only operate on a 5% GDP growth rate for the second half of this year, which would put the full year number at around 7.5%…Essentially we’ve got some growth, but not in exports, not in consumer goods, and not in the stock markets via equity issuance.

If we see anything it will be in the construction, agricultural, and industrial sectors, here and there. This would keep some latent demand going for commodities like copper, iron ore, and aluminum…not enough to overcome the net pullbacks in the rest of the world, but enough to keep major commodities from collapsing to 1990’s levels.

Amidst all the confusion and conspiracy theories, there’s one thing I definitely believe about China - they are eager enough (and likely smart enough) to not pass up this unique opportunity to make up ground on the G7 economies. Somewhere right now in a high-rise office in China there’s a group of economists figuring out how China can best emerge from this global recession a nation ready to become the largest economy in the world. They need to have infrastructure to do it. They need to foster internal, organic growth in basic industries, and create broad classes of laborers in their country servicing those basic industries. They also need to unify their patchwork of policies, restrictions, and business practices. Whatever China wants or needs to buy to get the job done, the economics to do so are the best they’ve ever been. Look for them to take advantage.

A note on Our Holdings

China is vital clue in the mystery to determine just how healthy (or sick) the global economy is. It’s also vital to several of the holdings in the Secular Trends Portfolio - holdings like Peabody Energy (BTU) that are capitalizing on China breaking a long trend and becoming a net importer of coal in 2008.

Or Freeport-McMoRan, the battle-weary copper producer that has seen its market cap fall below the value it bought Phelps Dodge for just two years ago. With the rest of the world already in freeze mode, China is a last bastion of hope in support of demand (and a plummeting copper price).

Now repeat all the above but insert “aluminum” for “copper”, and you get the story of Alcoa (AA) in the past month.

Ryan Barnes

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