By David Sterman
According to official data, the Chinese economy is cooling a bit, with 2012 growth projected to come in around 7% or 8% - a multi-year low.
Don't you believe it.
Statistics provided by the Chinese government are strictly a form of propaganda, used to influence global markets and quell domestic social unrest. According to many economists that work outside of the government, the Chinese economy is growing at a much slower pace, a result of sharply-falling exports and manufacturing activity.
How do we know this? Because commodity prices have been slumping badly, and China's insatiable demand for raw materials is now the single-biggest factor in commodity markets.
Consider these stats:
- Copper prices have fallen to a recent $3.40 from $4.50 per pound last summer.
- Crude oil prices have dropped 15% in just one month.
- Iron ore prices have fallen nearly 10% in the past month as China decided to forego bidding on recent spot market shipments.
Yet here's the good news for commodity investors: China's leaders tend to panic in the face of any major slowdown for fear that social troubles will bubble up. Back in 2008, they launched a half-trillion dollar stimulus plan to jump start the economy, and the efforts are now seen as a key factor behind China's ability to keep growing even as the economies of key trading partners fell into recession.
Chinese leaders are taking action again. In recent months, through the country's National Development and Reform Commission (NDRC), a rising number of massive projects are getting the green light, from steel mills to housing to wind turbines. Roughly 200 projects are typically announced by the NDRC each month. That figure moved 20% higher in March, April and May.
"Infrastructure investment will be the de facto key policy tool in the next few months, which supports our forecast for a rebound in growth in H2," analysts at Societe Generale recently noted. And China's increase in projects should set the stage for an eventual rebound in economic activity -- and commodity prices.
In addition the rising tide of projects, here's what else the Chinese government has done in just the last 30 days:
- Cut the required reserve ratio for banks by 50 basis points.
- Provided several billions of dollars in subsidies to buy more energy-efficient home appliances.
- Streamlined regulations to boost investment in highways, medical institutions, railway projects and the banking industry.
A tilt toward consumerism
Even as the government applies a jolt to the economy, it's fair to wonder whether China can avoid a deep slump while Europe -- its leading trade partner -- is in such a funk. Yet the nature of China's economy is shifting from a pure export focus to more balanced one that relies on more domestic demand. And an increasingly affluent (and growing) Chinese middle class will likely lead to more demand for everything from houses to jewelry to cars -- all of which should help commodity prices in one way or another in the long term.
Waiting for the Fed
Looking beyond China, there is another, perhaps more powerful reason to anticipate a rebound for commodities prices. A number of economists say the U.S. economy will likely slow down in coming months, in large part due to the paralysis associated with Europe and our own year-end looming tax battles. They add that the Federal Reserve stands ready to support the economy through another injection of liquidity into bond markets -- known as QE3. The prior two programs of quantitative easing gave a solid boost to commodity prices for a very straightforward reason: the added liquidity injected into the economy leads to a search for more speculative assets, such as gold, oil, copper and even stocks -- rather than low-interest bonds.
In effect, China and the United States are already -- or soon will be -- taking steps to boost their economies. This doesn't mean commodity prices have hit bottom right now and will soon turn up. Yet it does mean that the factors behind the recent commodity sell-off will eventually reverse.
The ways to play
I remain a big fan of Freeport-McMoRan (FCX) and Alcoa (AA), both of which are in my $100,000 Real-Money Portfolio. Though copper prices have been weakening, it's important to note that the copper market is expected to remain under-supplied this year. Aluminum prices are already so low --at a recent ninety cents per pound -- that high-cost processing plants are slowly being taken off-line, which should eventually lead to firming prices.
Beyond these two stocks, there are other bargains emerging in the commodity space. For example, Brazilian mining firm Vale (VALE) has shed roughly $75 billion in market value in the past year, and trades for just 5.5 times (depressed) 2012 profits. ArcelorMittal (MT), the world's largest steel maker, has seen its stock fall 86% to a recent $14, from $100 back in 2008.
Risks to Consider: All of these stocks carry the risk that the global economy in general -- and China in particular -- comes in for a very hard landing. These commodity and share prices are already beginning to reflect such a dire outcome.
I still prefer Alcoa and Freeport-McMoRan because their balance sheets provide more of a backstop, though ArcelorMittal and other commodity stocks might have even more upside when sentiments toward commodities reverse. Either way, you should be looking to add exposure to these stocks in your portfolio soon.
Disclosure: David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of FCX, AA in one or more if its “real money” portfolios.