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Summary

  • Recent Chinese economic news has been surprisingly slow.
  • This economic weakness will spread if the troubles continue. Some thoughts about how markets might perform should the weakness continue.
  • Why there may be reasons to favor the long side of the Canadian Dollar.

Recently, the Chinese economic news has been dismal. Announced late Friday was the Chinese Trade Balance, and it was a shocker. Instead of a 14.5B (Yuan - $2.36B U.S.) surplus, it was announced there was a 22.98B (Yuan - 3.74 $U.S.) deficit. For some reason it was the month the exports stopped, or at least dropped. This report was preceded with the first Chinese failure of a business to make a loan repayment. On Friday, Shanghai Chaori Solar Energy Science & Technology Co. defaulted, failing to pay interest due on bonds.

According to some observers, this is only the beginning of troubles caused by the aggressive growth on Chinese credit. Here are some of the excepts of an article by Prem Watsa, courtesy of Zero Hedge:

"There is a monstrous real estate and construction bubble in China, which could burst anytime. ...In case you continue to be a skeptic, here are a few observations from Anne Stevenson Yang, an American who has been in China for over 20 years and is the founder of JCapital Research in Beijing."

"1. China added 5.9 billion square meters of commercial buildings between 2008 and 2012 - the equivalent of more than 50 Manhattans - in just five years!

2. In 2012, China completed about 2 billion square meters of residential floor space - approximately 20 million units. For perspective, the U.S. at its peak built 2 million homes in a year.

3. At the end of 2013, China had about 6.6 billion square meters of new residential space under construction, around 60 million units.

4. Yinchuan, a city of 1.2 million people including the suburbs, has 30 million square meters of available apartments - roughly 300,000 units that could house 900,000 people. This is in addition to the delivered but unoccupied units. The city of Guiyang, capital of Guizhou Province, has roughly 5.5 million extra units for a city of 5 million.

5. In almost every city Anne has visited, pretty much the whole existing housing stock has been replicated and is empty.

6. Home ownership rates in China are estimated to be over 100% versus 65% in the U.S. Many cities report ownership over 200%. Tangshan, near Beijing, is one.

7. This real estate boom could only be financed through unrestrained credit growth. Since 2009, the Chinese banks have grown by the equivalent of the entire U.S. banking system or 15% of world GDP...."

Most of what China does tends to be large, and it should not be surprising China has created the world's largest real estate bubble. When the bubble breaks, the asset destruction will not be confined to just real estate, nor will the pain be contained in China. It is now a global economy and we all get to share.

One of the mysteries of the Chinese economy is the size and role of the shadow bankers. Who are they? How big are they, and who they lend to? Are they similar to sub-prime lenders in the Western world dealing with mysterious derivatives?

Recently the shadow bankers have been accepting iron ore as well as copper ore for collateral. Some attribute the massive build in stocks of iron ore delivered to China to be a result of the demand for collateral, not demand for ore to make steel. In either event, the spot glut of ore has resulted in it trading under 1.05/ton CIF Tianjin yesterday. This is down from a trade in the mid teens last week, and a trade over 140/MT last August.

With over a million tons of ore delivered to China, it is little wonder buyers for the steel mills have become, shall we say, selective in their purchases. Perhaps the demand for steel used in construction is slowing or perhaps the users are merely trying to get a better price. No matter which, the users of ore for making steel, or the shadow bankers taking the ore receipts for collateral, both have problems.

This is where Chinese business contraction starts taking its toll on suppliers. Certainly, the imports of ore by China will slow as the supply glut is worked off, but in free markets, it takes time for the price change to impact the market.

Traders are aware that China is the biggest market for Australian exports, and iron ore is the biggest product they export. This does not mean the Aussies are in trouble today. In January, Australian exports reached an all time high of 29,759M (million) Australian dollar in January of 2014 up from 28,691M Australian dollar in December of 2013. But China is not the only destination for exports. For the month China took 27% of the exports, Japan took 17%, Korea 7% and India 6%. Further, the biggest exports from Australia were classified as manufactured goods at 33%. Commodity exports were iron ore and gold 28%, followed by coal 18%, and oil and gas 9% of the total.

Still these numbers are history. Where you have been is interesting but where you are going is more important. If the Chinese market is slowing, this is physiologically important for the Aussie, and this, combined with the flow of funds, are the most important fundamentals in forex. Besides, if the Chinese economy is faltering, this will have a negative impact on Australia's other customers - Japan, Korea and India.

For the past three months, speculators have favored the short side of the Australian dollar. According to the COT reports, they built their speculative short up to 86.8K contracts in the report on the 28th of January. Trade on that day was around .8780, near the recent low. It appears there was subdued short covering that took the AUDUSD (FXA, UUP, UDN) back up to the .90 handle while the spec short position was declining to about 55K. Considering the positive Australian dollar data and the short covering in the Aussie, to me the Aussie rally looks feeble.

Rather than sell the AUDUSD, we would like to consider selling the Aussie versus the Canadian Dollar (FXC). Since the beginning of 2014, there were some bad Canadian numbers printed and the Canadian dollar has lost to the USD. Against the Australian dollar, the Canadian dollar lost even more, 700 pips, from .94 to 1.01.

Yes, commodities are part of the Canadian export mix, but most of this is energy products, which amounted to 23% of its exports in 2013, according to Statcan. Ore and mining accounted for only 3.7% of total exports. Canada produces and exports many manufactured value added products. Motor vehicles and parts accounted for 14% of total exports. The US takes 79% of total Canadian exports, and near term, may prove to be a more robust market than China.

My preference is to sell the AUDCAD at 100.00 or better, but we will need a recovery to get it sold there. Perhaps it is best to sell half a unit above .9950 and the other half on a return above parity. Manage your money carefully.

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Source: Poor Chinese News Weighs On The Australian Dollar