China doomsayers getting louder…

China doomsayers getting louder…

As you know, we have been barking loudly about a deterioration in China for two years. For investors however, it is often less important that fundamentals are deteriorating, and more important that sentiment isn’t. But sentiment does appear to be deteriorating too.

It is easy to fall under the spell of ‘doom and gloomers’, so we tend to avoid visiting their sites and their blogs. In any event, the world’s most successful investors tend to be either optimistic, opportunists, or both. Indeed, through wars, financial crises, assassinations and all manner of threats the world and its economies have delivered fantastic opportunities for wealth creation and preservation. Rarely do you find perennial bears or pessimists in the ranks of the rich.

So we present this collection of observations merely as evidence of the shifting sentiment towards the economy and markets, and while it perhaps paints a picture of impending doom, remember a correction in markets requires participants to adopt the doomsayers’ views. They may or may not be adopted, but the drums are getting louder.

First, a little economics 101

China has been reported as has having enormous foreign exchange reserves. These are hoardings of foreign currency that the Chinese have amassed from selling their products overseas. Using these foreign reserves, the country buys, for example, US bonds. Over in the US, this foreign purchase of bonds keeps their interest rates low and provides much needed funds to spur economic growth. At the same time, the Chinese net accumulation of foreign reserves keeps upward pressure on the foreign currency, in turn making their competitors’ exports relatively expensive and thus Chinese exports more attractively priced.

It all works well provided the reserves keep growing.

What’s happening now?

Russell Napier, the highly regarded strategist and economist at CLSA reckons that the recently emergent hopes for an early recovery in the global economy may be overoptimistic. Observing the expansion and contraction of China’s FX reserves, he notes that the expansion phase is about to end; Chinese reserves growth has decelerated dramatically over the last five years and is now close to zero. Keep in mind that rates of expansion and contraction in Chinese FX reserves have coincided with global economic expansions and contractions respectively.

Russell Napier describes the graph below thus:

“It is the most important chart in the world. The growth in Chinese reserves has determined all the key developments in financial markets in the last two decades. It printed lots of currency and artificially depressed the US yield curve. It has been the cornerstone of global growth, and now it’s over.”

Napier also noted elsewhere that the last time the Chinese foreign exchange reserve growth rate was below 10% was at the end of the 1990s, just before the bursting of the technology stock market bubble and a recession. The recovery in the growth rate from 2001 onwards was followed by the economic boom of the last decade. The growth rate turned down decisively in 2007, just before the onset of the financial crisis.

Keep in mind that there are many apparently strong correlations that aren’t guaranteed to persist.

Further, there are also growing fears that China’s debt levels cannot expand further to fuel growth there.

On the ABC Radio’s AM program, Peter Ryan reported that one of China’s top auditors has revealed that his accounting firm has stopped approving requests from local governments to increase their debt exposures.

The International Monetary Fund has certainly been warning about China’s debt levels, and investment banks and ratings agencies have been on the front foot after failing to read the initial signs leading up to the GFC.

But there’s a very big focus on China’s real estate sector, which accounts for 13 per cent of the country’s GDP. Already there has been a sharp decline in values. But unless Chinese authorities intervene to stop a real estate bubble, some economists are quite worried that there could be much more than a correction -rather a crash that could rival the US one. Which of course almost brought down the US economy back in 2008.


German 10 year bonds are at 1.23%, UK bonds at 1.68%, US at 1.7%, and around the world bond rates have been collapsing. When you look at these rates declining and consider the recent fall in the price of gold, one can’t help but think deflation is a fear taking hold.


Project delays in the Australian resource sector, which we wrote about here, could wipe a couple of percent off our GDP, suggesting we may not be immune.

Of course we remain cautiously optimistic about a few investment themes, and hope that the re-emergence of fearful sentiment will provide value for Montgomery to invest the high levels of cash we have been holding for the last couple of months.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Are all commentators to addicted to growth and then even the rate of growth?
    I don’t understand the pessimism if as predicted China does not grow at 8-9% as in the past but only grows at, say, 7%. Does that not mean that they will still buy 7% more coal and iron ore than last year?

    • No David. It doesn’t at all. Just as a higher growth rate can have an exponential effect on demand of some inputs, so a declining can have precisely the opposite impact. And when supply is geared up for much higher demand that doesn’t materialise…well….you can work it out.

    • I think the whole buzz is justified when you realize how much of South East Asia’s economy and Australia’s economy is reliant on how China fares.

      The question isn’t only on what the growth % is, but rather where the growth is coming from. Since much of China’s GDP growth was contributed by fixed asset investments over the past decade, if China decides to slowdown on this area the effects on Australia would be to say the least, detrimental.

      Much of the wealth enjoyed by Australians over the years were in line with unprecedented credit expansion, one that was justified in the assumption that growth would continue at this rate.

      China has no reason to play price-support for commodities such as iron ore, which despite recent corrections, is still 10 times 2003 levels. In the long run of 20 years, China will have consistent demand for iron ore. But China does not have to accept iron ore at such ridiculous prices.

      But then again, we all know why China is playing the “nice guy” in this equation and keeping friendly trade ties…

  2. Roger I am off to China again soon for a couple of weeks for my own company selling into their major retailers in the imported food market. Imported Food is a good measure as although it is a staple product it is also non essential for life, the demand can be met by locally supplier food at a far lower cost. But at the same time the demand soars as the increasingly middle class population do not want to consumer or feed their family local food they do not trust the source of.

    I’ll report back on my observations on my return. Perhaps indeed China is starting to sink. I’d rather look for myself than listen to the noise from the millions outside China who cannot comprehend how a heavily commercial yet command economy works.

    I’ll try to get some feedback from my partner’s family in the biggest bank to see what they are reading in the ‘green tea leaves’

  3. With numerous Quantitative Easing in USA, could it be that China no longer thinks buying USDs is a prudent activity?

    Officially China holds about 2000 metric tonnes of Gold but as a percentage of total reserves that’s LESS THAN 2% when US, Germany and Italy are at or close to 75% and France is at 63%. So, we know 2000 metric tonnes is WAY WAY OFF. For more than a decade, China has been hoarding gold, keeping all the gold they produce as well as (quietly) buying off market. I can’t help but think the recent correction in the Gold price thanks to Ed Bernanke made the Beijing Mandarins smile gleefully. That’s especially the case if we believe the world will eventually return to the Gold standard when USD go into a “death spiral”

  4. matthew.connors2

    For years China mockers have been saying they need to appreciate thier currency, stop building empty cities, factories and roads, and move towards a more consumer driven society with more services and products, rather then a focus on exports exports exports.

    China is finally starting to turn into an albeit early, but maturing economy, which, now the same doomsday commentators who where mocking it for being export driven are now mocking its economic slowdown, as it matures.

    Its certainly a positive thing that China is slowly appreciating it currency, its focusing on delivering services to its people and products to its consumers. All well overdue.

    If it continued down the path of rapid inflation, huge stimulus and only a focus on exports, all the commentators would be predicting an inevitable burst of the bubble.

    I see this as a natural progression for china. In 2008 China gave its people a lot more bargaining power for wages and its now paying off through slightly lower economic activity, but a shift in Chinas economy , and one for the better if you ask me.

  5. Scary stuff indeed. Why wait for the next shoe to drop? Better to take your profits now and wait for a re-entry point. After all, if you are a european/ american fund manager and you have had a good year, why spoil it all by overstaying at the party? The last thing you want is frantic calls to your mobile as you cruise the mediterranean on your yacht this northern summer.
    Or is this just an urban myth? :-)

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