Time To Avoid Industrial Commodities, As China's Growth Engine Stalls

 |  Includes: FXI
by: Disruptive Investor

There is no doubt in anyone's mind that the Chinese economy is slowing down. However, the debate is on related to the extent of the slowdown. It is also not a great idea just to look at Government published GDP numbers and talk about a hard or soft landing for the Chinese economy. These numbers can be doctored and it is hard to rely on GDP numbers for a large economy like China.

Therefore, this article discusses some of the more real indicators of a slowdown in China and the investment implications of the slowdown.

The first indicator is the China business cycle index, which has slumped from 113 in June 2011 to 87 in April 2012, indicating significant slowdown in business activity. Profits of industrial enterprises have been on a decline in the last four months, indicating the impact of the slowdown on the corporate sector. Further, the growth in China after the financial crisis was largely fueled by robust growth in money supply, which is also on the decline for the last 10 months.

Click to enlargeChina Business Cycle IndexClick to enlarge

The second important indicator of a meaningful slowdown in China is the Baltic Dry Index. The Baltic index is near the 2008 levels when there was a complete credit freeze and the global economy was in a free-fall. Since the index measures the charter rates for shipping dry bulk commodities such as coal, grain and iron ore, it can be considered to be one of the best indicators to determine the extent of slowdown.

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Besides these two important indicators, some other indicators given below have also exhibited slump in growth in the recent past, indicating the weakness in the Chinese economy.

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I would not be surprised if the real economic growth in China is not more than 5% currently. In such a scenario, one needs to take some calculated investment decisions.

I would personally look to do the following in the near to medium term:

1) Avoid exposure to industrial commodities, as China is the largest consumer of several industrial commodities and commodity prices should fall further. In line with this, I would also avoid exposure to the currencies of commodity producers. At the same time, a weak Baltic dry index means sluggish growth for shipping companies, which I would look to avoid in the medium term

2) Avoid exposure to the Chinese stock markets. However, on further global correction, I would look to buy some quality stocks through iShares FTSE China 25 Index ETF (NYSEARCA:FXI).

3) Avoid exposure to crude oil and exploration companies, since the Chinese slowdown coupled with slowdown in Europe and U.S., will put downward pressure on crude oil prices

Finally, in my opinion, having exposure to the dollar in the medium-term might still be a good idea, along with slow accumulation of gold. Central Bankers would resort to quantitative easing on further indications of a slowdown and all hard assets will benefit.

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