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Metallurgical coal stocks have been big outperformers of late based on the strength of China. Ironic that China is now admitting it has overcapacity in this area... and is 'studying' how to address it. This adds to the mosaic of potential issues facing the global economy in the coming 12 months.

Thus far US investors have ignored the data points coming out of China the past 45 days. I think that is very dangerous considering China demand and consumption was the pretext for a great portion of this rally from March. As always the news only matters when it matters. More and more negative data points are building. When the market recognizes them is an open question - caution is warranted however. Sun Tzu is gathering forces in the mountains, waiting to strike...

It is now clear from the actions and words in the past 1.5 months that China realizes the massive loan growth in 1st half 2009 was excessive and they are taking a multitude of actions to slowly let the air out. [Aug 24, 2009: Bloomberg - Coal Rally Ending as China Shuns Imports, Opens Mines] As I said a few weeks ago, the complete "out of control" nature of loan growth the first 6 months of the year had me more bearish on China's intermediate term (2-3 years out), since so many of these loans will certainly go bad. But I was thinking like an American, not realizing that the Chinese just won't let bubbles spiral out of control for 3-4-5 years straight as we do here. These type of actions are a net positive in the intermediate term, while obviously a potential drag in the near term for China. I, for one, am glad to see it.

Today's comments might be an opportunity to short coal companies which have a heavier emphasis on metallurgical coal - i.e. a Walter Industries (NYSE:WLT).

This also helps to explain the weakness in the Baltic Dry Index we've been flagging for weeks - coal and iron ore are 2 of the main products being shipped on these vessels. [Aug 7, 2009: Baltic Dry Index has Worst Week Since October 2008 - Blame China. Precursor to Loan Growth Slowing?] It's all starting to make more sense now.

  • China’s cabinet said it’s studying curbs on overcapacity in industries including steel and cement as policy makers seek to rein in investment growth fueled by a record credit expansion this year.
  • The government will also increase “guidance” over parts of the coal, glass and power industries, the State Council said on its Web site today. Controls on stock and bond sales by companies in targeted sectors will be strengthened, it said.
  • China is aiming to prevent excessive investment in the world’s biggest user of steel and cement without imposing restrictions that may endanger an economic recovery.
  • “This is tightening but it’s not a total shutdown,” Ken Peng, an economist with Citigroup Inc., said in Beijing. “Policy hasn’t reversed but they are contemplating moves that have a lesser impact on the broader economy.”
  • The restrictions are “good over the long term for these industries, which have real serious surpluses,” said David Fang, a director with the China Coal Transport and Distribution Association in Beijing. The government “tolerated” overcapacity in the first half as they “urgently needed an economic recovery amid the global recession,” he said.

Here is a great example of the mismatch in supply and demand (take all figures with grain of salt, but directionally you get the idea)

  • Li Yizhong, China’s industry minister, earlier this month ordered the steel industry to refrain from expanding capacity. Mills have capacity to produce 660 million metric tons of steel each year and there’s demand for 470 million tons, Yi said.
  • “China’s iron and steel industry is the worst in the country in terms of excess capacity,” Li said Aug. 13. “I would like to call on the industry: No new projects for three years.”

Again, China is essentially moving the commodities market worldwide [May 13, 2009: Commodities - It's China's World: We Just Live in It] - which is why it is imperative to read every darn thing coming out of the country. It used to be when the US sneezed the world caught a cold, now we have to be on the lookout for Chinese wheezes.

  • China produced 500.5 million tons of steel last year as the world’s largest producer. That’s more than the combined output of Japan, the U.S., Russia and India, the next four biggest makers, according to the World Steel Association. (incredible)
  • In the first seven months, China accounted for almost half of global output. (incredible)
  • China produced an estimated 1.45 billion tons of cement last year, accounting for half of world output and making it more than eight times bigger than its nearest rival India, (incredible!!)

This entire piece speaks to the difference between American and Chinese philosophy - while both have now adopted a central command style economy; the U.S. in the last few decades mostly through the Federal Reserve is pulling levers of easy money any time the US economy falters, and the Chinese are doing this in a much more broad way - the "back side" of the stimulus is how they differ.

In China - when easy money creates potential bubbles - the government moves to try to prick them; this was done as recently as post Olympics 2008. In the U.S. officials feign inability to spot bubbles and hence can do nothing to stop them ... the bubbles are invisible apparently. They will just allow things to bloat, and then the Fed will "fix them" after the fact, but doing the exact same thing that caused the bubble in the first place: even more easy money. Hence we just move from 1 bubble to the next, and the same actors profit from each bubble and clean up. It's all just become a bit humorous at this point.

Source: When the Chinese Sneeze, Commodities Catch a Cold