China's Former Growth Rate Is Over: Believe It

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Includes: CMD-OLD, FXI, UCD
by: Gary Bourgeault

Summary

China's past economic growth rate is finished.

What is the new rebalance? We don't know yet.

How this will affect commodities.

Consumer products should be the place to look going forward.

There seems to be a lot of uncertainty, and in some cases, false hopes, concerning China's impact on parts of the world's economy. Investors need to believe it when China says it has changed its economic focus to the development of a more robust consumer spending economy. That's its future, and that is where its economic growth will be.

That suggests every part of the global economy China had a significant impact on in the past will no longer enjoy it as a positive catalysts near past levels.

Where the challenge lies isn't with the acknowledgement of that, as there can be no doubt concerning the reality, as the commodity sector testifies to. The problem is we have no idea where this rebalancing will end up because of the lack of quality data that has come out of China in the past, which can't be considered accurate.

Only the market, over time, will be able to decipher the extent of this decline and how it influences the supply and demand equation.

That will be the same with consumer spending, where the numbers are sure to be reported as higher than the amount actually spent, as China has determined its economic growth rate is going to be in the range of 6.5 percent to 7 percent, and you can be sure that is what will be reported in the years ahead.

How investors should handle that is to look at specific company earnings reports of those doing business in the retail sector of China to get a more accurate look at what is really happening.

Concerning commodities, demand levels in China will never return. There may be temporary pockets surrounding specific commodities China may acquire because they've dropped to very desirous price levels, but nothing sustainable in relationship to past commodity demand will ever return.

China's economic rebalance

What is impossible to determine at this time is how all of this will rebalance, because of China's practice of reporting on "official" growth rates rather than actual growth rates. I'm specifically referring to commodity demand here.

Even though there are numerous investors that have followed commodities for years, we've entered a new environment that has never been faced in our lifetimes, which is the unprecedented growth of China which triggered the enormous demand for commodities, and the following decline in demand, which when combined with dubious data, leaves a lot of uncertainty on the table. This is why so many price projections and expectations of a bottom and rebound are inaccurate.

What is happening is analysts are making determinations based upon past market patterns, which can't be applied to what is being faced today, which is the fallout from one of the greatest economic growth stories in world history.

I understand we can debate the legitimacy of a lot of what China did, such as its ghost cities and numerous other boondoggles. But whether legitimate market demand or artificial, it still increased demand for raw materials. That of course is part of the problem in analyzing where we're now at.

Not only has legitimate economic growth slowed down, but China has obviously pulled back from its building of projects, which have no real demand.

What's ahead for commodities

Hopefully, most of us have recognized that the commodity supercycle is over. Not only is it over, but it will never return to the performance it had when China was buying up unprecedented amounts of raw materials for its building projects.

That leaves a rebalancing of the entire complex, which in my view, could take several years to play out.

The challenge is to know what the new bottom is actually going to be, and how to identify the new demand environment once that is found. This will of course be determined on an individual basis for most commodities.

I don't believe we've found where the overall bottom is, which is why there has been consistency in price estimates and demand projections. It's also why whenever the market thinks a bottom has been reached, prices drop even further.

Again, my thought is this is because most analysts are drawing conclusions based upon past commodity and economic cycles, when this is a unique circumstance in history not likely to be repeated.

After all, when will another China emerge? India, once it gets its economic act together, will eventually provide some demand, but it has different aspirations than China does, and probably won't engage in some of the types of meaningless projects China has in order to be perceived as a major economic power.

What's ahead for commodities is more of the same. Until the sector has rebalanced and we know what the real demand is in a world where China's economic growth is subdued, there will be no way of accurately identifying market bottoms and market-based demand.

Part of this is slowing growth, along with China working through existing inventory, which in many cases it has acquired at very favorable prices.

Not only is all of this true with base metals, but it's also true with energy as well.

Consumer spending and China

When looking to the impact of China, the place to focus on is in consumer spending, which is the stated direction Chinese leaders are taking the country. I believe them.

As the oil debacle has shown, those countries without enough economic diversity are far more subject to deeper downturns than those with economies built on a variety of healthy industries.

In regard to consumer spending, China won't be any different than any other country. When people are confident about the economy, jobs, and personal income, they will spend more. There also has to be a strong credit system in place to cater to those that use debt to acquire products and services. China has been working on improving those areas.

A good example of how to look at China and consumer spending is Nike (NYSE:NKE), which has been very successful in branding in the country and in getting Chinese consumers to buy its products.

China isn't only trying to bolster its manufacturing sector internally, but is looking to global brands as part of its consumer-spending strategy. The Chinese have shown they are more than willing to spend on brands that know how to win them over.

The point is consumer spending isn't reliant upon goods produced within a country to be successful, but on spending itself. The Chinese have proven they're willing to spend on quality products no matter where they're from.

Consumer spending will never bring China back to its past growth trajectory, but it will eventually provide with steady and consistent growth which should provide it with the type of economic diversity it's looking for.

Conclusion

The economic glory days of China, as it relates to the pace of economic growth, are over. It'll never enjoy the types of double-digit annual growth rate it did in the past, and in all probability, isn't growing near the stated pace it asserts today.

This means commodities will have to rebalance and find a new bottom before we can make a determination on what the new supply and demand situation really is.

There is no doubt China is really transitioning to consumer spending as its next targeted growth area, in order to diversify its economy and provide long-term economic health and realistic growth.

Ignore anyone that suggests there will be a rebound in commodities based upon China. That party is totally over. That doesn't mean there won't be Chinese demand. It means it will take time to discover what the new demand levels will be.

One good thing about the transition to a consumer spending economy as it relates to investing, is we can easily ignore the official data coming out of China and base our investment decisions on how well a service company is doing there. That will be more accurate and trustworthy than the numbers released by the Chinese government.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.