A Short on China is a Short on Australia

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–Only 36 more days until the U.S. Fed’s quantitative easing (part two) policy is set to expire. It’s been our contention here the Fed needs a big sell off in stocks and commodities so it can justify the next round of asset purchases. With asset prices—especially precious metals and oil high -QE3 would be a tough sell in the court of public opinion (might look inflationary).

–But if you wipe tens or hundreds of billions of dollars in market value from the stock market, and if you get silver shedding 25% in short order, then maybe the argument for more quantitative easing is an easier sell. Mind you we’re just speculating here. But the speculation is that a teeth-rattling sell-off in markets between now and the end of June would suit the Fed’s purposes quite nicely.

–Enough of the guessing, though. Let’s turn to the prediction from Goldman Sachs and Morgan Stanley that Brent Crude oil will hit $130/barrel in 2012. Brent Crude is currently trading at $112. On the surface, predicting a 16% rise in oil prices over the next six months seems pretty…bland. Before selling off in early April, Brent Crude was up 30% for the year.

–Goldman’s analysts think demand growth and supply constraints will support oil prices. They wrote that, “Economic growth will likely be sufficient to tighten key supply-constrained markets in the second half, leading to higher prices from current levels.” Their previous forecast was $107/barrel.

–Behind the tortured economist-speak is the idea that demand in key markets is still growing and supply from key markets will remain uncertain (that means you, Middle East and North Africa). On the demand side, energy research Platts has something to say about China. Platt’s say, “China’s demand for oil will grow 4-5% a year to hit 530 million-560 million metric tonnes (10.6 million b/d-11.3 million b/d) in 2015, with transport fuel and chemical feedstocks driving the increase.”

–Even if demand slows a bit in the coming years, Standard Chartered Bank reckons China’s demand for oil imports will catch up with the US by about 2030. Both behemoths—assuming they have not seamlessly switched to industrial economies that run on wind, solar, hydro, and warm fuzzies—will be importing around 18 million barrels of oil a day.

–From where? Good question. At his talk in Houston, Saudi Aramco VP of Production Saad Turaiki revealed that his company (and his country) would be ramping up their on- and off-shore gas exploration and production. Considering the Saudis used to flare their natural gas (it just got in the way of the oil), this was a surprise. What are they up to?

–The Saudis want to run their domestic economy on gas and save all their valuable crude oil for export to the world’s oil have-nots. Energy intensive domestic industries include power generation, petrochemicals, and desalination. All of these can run on gas, saving the oil for export.

–That all sounds suspiciously like a national energy strategy grounded in geopolitical reality (as opposed to ideological fantasy).

–But could the Saudi strategy be flawed? Of course it could! It would be flawed, for instance, if the world fell into prolonged deflationary depression. There would be a lot less oil demand then, especially from China.

–A collapse in China—at least a collapse in its high rates of commodity intensive fixes asset investment—is what U.S.-based short-seller Jim Chanos is predicting. Chanos says the great migration from the farm to the city is already complete in China. He says 900 million Chinese already live in urban areas, with 400 million living on the farm and not going anywhere anytime soon (who will run the farm?)

–If Chanos is right, China has already overbuilt in its commercial and residential property sectors. All those 65 million vacant apartments won’t be snatched up, and certainly not at these prices (when per capita wage growth lags median house price growth). And with Chinese regulators trying to contain socially destabilising inflation, Chanos reckons the bust is a matter of time.

–But as our mate in Oregon Dan Ferris pointed out recently, a short on China is really a short on commodities. Or, to take it one step further, a short on China is really a short on Australia, Brazil, and Canada. All of those commodity exporters have enjoyed strong exports and currencies thanks to China’s fixed asset boom.

–By the way, by “fixed asset boom” we mean an investment boom in infrastructure, roads, bridges, and real estate. This kind of investment boom requires lots of steel, concrete, zinc, copper and virtually everything else Australia has. This is why a short on China is also a short on BHP. Incidentally, our own Slipstream Trader Murray Dawes has recently put on a similar trade. Details about his strategy can be found here.

–There are two reasons, then, you could expect to see Australian stocks fall a lot further in the coming few weeks. One, the Fed won’t support asset prices in the U.S. It wants a good, nerve rattling correction to set the stage for the next round of quantitative easing. If Aussie stocks continue to follow the US lead (as they have), then stocks here will correct. Two, China’s crack-down on official bank lending will hurt commodity demand.

–Of course now that we’re on record with a mini-crash alert, Aussie stocks will probably rise by ten percent by the end of the month. In the meantime, look out.

Dan Denning
Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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7 Comments on "A Short on China is a Short on Australia"

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Biker
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Your last sentence is really a complete cop-out, Dan.
You build a strongly-argued rational case, then bail at 1500 feet.

Whatever happened to _conviction_ ?!~ :D

Biker
Guest

You know, CONVICTION…. where you put up a case, support it, then conclude with an assurance that, based on your argument, you’re right. :D

Jeez, I miss The Old Shoes. Now _there_ was a fella prepared to go RIGHT out on a limb… . ;)

The_Observer
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Why isn’t anyone factoring in the Indian factor which would possibly take up the slack from China and more? After all, the former is starting out on her infrastructure build-out as well.

Ned S
Guest

“Whatever happened to _conviction_ ?!”

It’s not easy being a bear Biker. Leastways it isn’t once one gets the hint that everybody who is anybody in the WHOLE world has decided that for nasty things to happen would be BAD! :)

Ned S
Guest

Well, a thought from someone else I read is that India is dependant on China Observer?

Me … I’m happy enough to just say I don’t know?!? :)

fred
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Dan,great! deep mind!!

Biker
Guest

Deep mined? It was a well-reasoned shaft until the last sentence…
which rendered it alluvial… . ;)

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