Defend Against The China Blahs With Gold; Avoid Commodities

 |  Includes: ABX, AUY, GG, GLD, JJC, JJN, LD, NEM, NGD, SLV, UUP
by: Robert Hallberg

Europe is in serious trouble, and the rest of the global economy also seems to be slowing down. This is not necessarily a reason to panic out of equities, since the market attempts to discount future earnings. It may already have priced in a recession. A reason for concern would be an unexpected slowdown that is not widely recognized by most market participants. Perhaps a slowdown in China presents this sort of scenario.

It appears that the crisis in Europe is drawing attention away from what's going on in China. And China has a huge influence on the rest of the world. Many have looked to China to pull us out of this economic recession.

It seems that China is experiencing a typical Austrian economic boom-bust cycle that is nearing a bust. The degree of mal-investment is unprecedented. The most noticeable signs of mal-investments are newly built cities with almost no inhabitants and giant new malls without any tenants. The root of the problem is that the banking industry is totally devoted to serving the State, and as a consequence a lot of bank lending is done with complete disregard for sound economics.

Taking in to account that most investors believe that China is making real and productive progress, and that its economy is strengthening, the next shoes to drop may just be the realization by most investors that the Chinese economy is going to bust.

Click to enlarge

China is indeed showing strong growth numbers on paper, although they are also slowing down. But these numbers do not account for “real” economic growth. Consider that GDP is made up of five variables; consumption, investment, government spending, and exports minus imports.

The Chinese economy is mostly made up of investments, not exports, and not consumption, and most of this is directed by the state. In this sort of environment it becomes easy for the state to target a GDP growth rate of 9 or 10 percent. All you need to do is build infrastructure projects such as new cities, new malls, etc.

Nevertheless, this sort of growth does not add much value and people will soon realize that a small city does not need a $7 billion railroad station, and a city with no inhabitants does not add much value to the economy. Furthermore, these projects are to a large degree debt financed by state owned banks, and when it’s realized that these projects are not profitable it will put tremendous stress on the Chinese banking system.

If the there is a meaningful slowdown or perhaps a crash, it will have a huge impact of the demand from China for commodities and other raw material. This will affect nearby countries including Australia, the Middle-East, Africa, and Latin America. These countries will be faced with lower commodity prices, especially industrial commodities. As a result they will buy less from China, causing a vicious downward spiral.

In this environment you want to be out of industrial commodities, especially things like copper (NYSEARCA:JJC), nickel (NYSEARCA:JJN) and lead (NYSEARCA:LD), to name a few. Silver (NYSEARCA:SLV) may take a hit, but it will probably make a quick correction, as it is in short supply and also has the status of a monetary metal. If it takes a dip, I would see this as a buying opportunity for silver.

The best place to park your money in the case of a significant slowdown is gold (NYSEARCA:GLD) and, to a lesser degree, senior gold production companies such as Newmont Mining (NYSE:NEM), Goldcorp (NYSE:GG), Barrick Gold Corporation (NYSE:ABX), New Gold Inc, (NYSEMKT:NGD) and Yamana Gold Inc (NYSE:AUY). The US dollar (NYSEARCA:UUP) may also have a rally, but I expect that to be short lived, as the US has its own set of financial problems.

Disclosure: I am long GLD, SLV, NGD, AUY.