Signs of change in China
In the past week we have seen an ever-growing number of news stories around China and the changing tide in their stance towards COVID-19. Since the early days of the pandemic, they have pursued a policy of Zero COVID. No matter the economic or social damage this caused, this was their policy.
In some sense the party line today is to continue the fight against COVID-19 however, at a local government level we have seen announcements last week that indicate a changing of the tide is upon us. For example, it was announced that a relaxation for the requirements for negative PCR tests to enter shopping centres and offices will be dropped. It would appear we are now entering a period where Beijing seems to be quietly accepting that China needs to live with COVID-19 to move forward, not fight against it.
It is also fair to say that there are signs that the people of China feel the same way given the recent protest rallies that have taken place last month.
Aside from relaxing the use of PCR tests we have also seen Beijing relaxing quarantine periods for those who fall ill, and a move to allow this to occur at home.
Given Australia’s trade ties to China we have continued to watch these developments closely, we are all aware of the pressure the strict COVID policies have placed on the Chinese economy. From an economic perspective any softening in the stance towards COVID would likely be advantageous.
These pressures can be directly seen in recent trends in China, where their import of oil has fallen to the lowest level since 1990, air traffic is down by 35 per cent, and their trade with partners such as South Korea fell by 25 per cent in November alone.
The question to then pose is; if China does take a stance to embrace living with COVID, what opportunities could that present investors?
One of the key areas that we have been watching closely of late has been the resources sector. The Montgomery Small Companies Fund has been active in its approach to investing in this area. At a high level we have positioned the portfolio to take advantage of long-term themes in resources such as decarbonisation, and more recently the structural trend around global energy security, as the world digests a future that is less reliant on Russian Gas supplies.
Over the past year we have seen significant strength in commodities such as coal, oil and lithium, driven by energy security and EV trends, however commodities such as copper and gold have been relatively weak. Despite copper’s positive medium-term fundamentals which are supported by decarbonisation and tight supply, the copper price has been soft this year as investors worry about the global macro backdrop given the red metal’s industrial use. Similarly, the broader risk-off environment has seen significant strength in the U.S. dollar which dents gold sentiment.
Looking forward, if we see China progressively reopening we could expect to see stronger demand for raw materials and increased air traffic which would provide a boost to global economic growth. This in turn would be supportive for copper and oil prices, as growing demand returns to underpin increases in these commodity prices. It is also likely that any change in stance towards risk (or a risk on trade) would also be supportive for the gold price. Of course, the balance would be what impact this higher demand would have on global inflation which central banks are currently fighting to bring down.
The Montgomery Small Companies Fund currently has around a quarter of its portfolio in resources, which is similar to the benchmark exposure. We have continued to actively review our allocation to best balance our exposure to long-term themes such as EVs and energy security against taking more tactical positions in opportunities like copper and gold where the outlook and valuation provide an interesting opportunity for investors. Additionally, we continue to focus on low-cost producers rather than more speculative explorers and developers.