In trying to make sense of the world and its economic trajectory, something I read this weekend struck me.
China’s Premier Wen recently issued his year-ahead commentary on economic growth in his country, and also implied a platform that may last for far more than a year (and in Chinese-speak, we could be talking about the next 10-20 years).
The headlines were “China lowers growth target!” To be precise, Wen lowered the nation’s growth goals from 8 percent to 7.5 percent. And historically, China’s announced growth objectives are regarded as the lower boundary of what would be an acceptable range.
So if past is prologue, 7.5 percent should really indicate “7.5 percent to 9 percent.” That’s pretty good for any country at any time in world history – except for China at this particular point in its history.
Still, what struck us as most important about Wen’s commentary was that the government wants to transition to an economy led by consumers rather than exports. We think China has been doing this all along, in bits and pieces, but apparently now it’s time to go all-in on it.
One major consequence of a consumer-led economy is the need for broad-based access to energy. And even in still developing China, clean energy will be preferred to conventional hydrocarbons for several reasons.
We know there’s a lot of debate about the phenomenon of Peak Oil (and Peak Everything), but it’s a debate we don’t want to be part of at the present time. For one thing, we don’t think the terms are defined that well. But in any event, what we do know from reading Chinese commentaries is that they do buy into the notion of not just Peak Oil, but Peak Hydrocarbons.
Several years ago, for example, we came across an academic paper penned by two Chinese professors who argued, as many others have, that even coal, which is so vital to China’s energy production, will peak some time in the next decade.
After hearing an analyst from India speak last week on that country’s pressing need for coal, we’re even more convinced of the Chinese position. And given that the Indian was sharing the stage with a noted Chinese prognosticator, we really doubt that the Chinese are oblivious to the world’s overall need for coal.
And before you mention shale, keep in mind that a recent article we mentioned in a previous Update said that China has put off all ambitions regarding shale “for at least a decade.” In China-speak, that could well mean “forever.”
Let’s consider the investment implications of China’s outlook with an eye on three critical energy metals:
Heavy rare earths, necessary for hybrid cars and windmills, among many other high-tech applications;
Silver, a critical metal in building out solar energy technologies; and of course,
Copper. Chinese copper demand growth has been in the neighborhood of 4 percent per annum, maybe a little more. And despite the expected slowdown in the overall economy, copper growth in China is likely to accelerate over the next two years to as much as 7 percent per annum.
We view all three of these metals/metal groups as scarce now, and likely to become exceedingly scarce as we move deeper into this decade.
For investors, not traders, probably the only way to play China’s frantic need to develop alternative energies is through the commodities they will require. That means rare earths are probably not on the agenda here, because China already controls virtually all of the heavy rare earths. So that leaves silver and copper.
None of the stocks related to these metals, such as the miners that produce the metals, are for the faint of heart. But certainly Freeport-McMoRan Copper & Gold (FCX) stands out, as do many junior copper and silver stocks, such as First Majestic Silver (AG), Endeavor Silver (EXK), and when it comes to panoply of metals, we will always name NovaGold Resources (NG), whose ultimate resource base is probably second to none relative to its share price.
We’re leaving out one other thing China will need, and need a lot of, to make this conversion. And that is hydrocarbons.
How do you extract and transport copper, or other vital commodities, without good old-fashioned hydrocarbons? How do you keep the plants generating and the factories functioning until the transition is complete? They’re going to need hydrocarbons – a lot of them.
But by and large the Chinese have decided that producing hydrocarbons are our job. U.S. policy, as we have spoken of before, has become dedicated to drilling and otherwise trying to find and extract as many hydrocarbons as possible.
We do not agree with the most optimistic observers, who claim the U.S. can become energy independent through hydrocarbons. And even if America somehow did manage to achieve this extraordinary objective, we believe it would only be ephemeral.
But more important is the fact that one of the major beneficiaries of such a situation, in addition to the U.S., would be China. Any additional hydrocarbons found in the world (and, of course, hydrocarbons are among the most fungible commodities, save for natural gas) will obviously benefit China in its transition.
You can become indignant at this and stomp your feet and ask “What the hell are we doing to our children?” But that’s not our role as investment advisors. Rather, whether you’re betting on China or the U.S., almost all roads lead to hydrocarbons and companies levered to hydrocarbon production. There are many that we like in this area, and we’ll name three: Occidental Petroleum (OXY), whose production growth could approach double digits within the next several years; Schlumberger Ltd. (SLB), whose new-found commitment to fracking in the U.S. should add points to its languishing U.S. growth; and Diamond Offshore Drilling (DO), a deepwater driller that was not involved in 2010’s BP debacle in the Gulf of Mexico. It’s a company that does not overbuild, and which has been paying a dividend which generates a yield of about 5 percent.
Betting on the success of these companies is one of the few areas in which we see China and the U.S. on the same side.
But that won’t last for long.
Disclosure: Leeb Group, its officers, directors, shareholders, employees and affiliated entities and/or clients of such affiliated entities may currently maintain direct or indirect ownership positions in financial instruments (i.e., stocks, bonds, options, warrants, etc.) of companies or entities whose underlying exposure is in the companies mentioned in this article.