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I've been writing quite a bit on some of the most predictable effects of the Chinese economy's slowdown. These have to do with linear impacts to steel, copper, iron ore, aluminum and perhaps other commodities that are construction related.

These impacts are linear to predict, because there are huge consuming sectors for those materials where a straight decrease in activity is to be expected, namely in residential construction (but also in auto production and shipbuilding). Even today, we got additional news that houses aren't selling and prices are dropping all over China, it's not hard to predict that since houses aren't selling and prices are dropping, in due time a lot less houses will be built. It's also not hard to predict that if China is building around 48 million dwellings and the U.S. were building less than 3 million at the top of the real estate bubble, when a reduction in activity hits this particular sector it will have huge worldwide consequences for the materials used in it.

Now, this particular thesis might sometimes be confused with a generic "China slowdown" thesis. The fact is that the two are different. They are different because this particular thesis will remain true even if China slows down very little. And indeed, there's the considerable chance that China won't slow down much, it will just transition from growth strongly based on investment (presently around 50% of GDP), to growth more pegged to consumption. If such were to happen, the growth could probably be kept at elevated levels, but the thesis regarding basic materials would not change much, because investment is a much more intensive consumer of those materials, than consumption (except maybe for autos).

This view of the Chinese slowdown, however, does have consequences. For instance, take crude. Some might say that if China slows down, crude might see a large negative impact, in line with copper, steel, aluminum, iron ore, etc. Yet, if China just makes a transition toward more consumption, and keeps being the largest auto market in the world, and knowing that these autos will join a fresh fleet (thus, there won't be much substitution or decommissioning), what this means is that China, even if it slows own some, will keep presenting an increased demand for oil - this is in stark contrast to what we can expect for iron ore or copper, where a decrease in absolute terms is to be expected.

It is thus perhaps not a coincidence that the market has been punishing some basic materials and the stocks that provide them, but not crude and energy companies. The market is, seemingly, already aware of this substantial difference.

Obviously, if China were to slow down enough, that is, to have an hard landing, then crude would also be impacted. But the huge difference here is that the basic materials thesis does not require such an hard landing, whereas for crude to suffer, it does require that scenario.


Stocks in basic materials should continue to be punished by the market, with the sector most likely to suffer the most being iron ore, where Rio Tinto (NYSE:RIO), VALE S.A. (NYSE:VALE) and BHP Billiton (NYSE:BHP) are the largest suppliers. Copper (NASDAQ:CU) and steel (NYSEARCA:SLX) should also be hit. Crude producers such as Exxon Mobil (NYSE:XOM) are actually safer, as they require a Chinese hard landing to feel the brunt of the slowdown, and it is possible that they might even benefit from a soft landing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.