China Syndrome

The China Syndrome

Just when China thought they had the game all figured out, we up and changed the rules (or maybe just ignored them…)

The deal was simple: We buy any cheap crap they could make (including plastic “meal deal” toys, cat food with melamine toxic resin in it, toys with lead paint, and just about everything that costs less than $1000 in just about every store…) and they would loan us the money to buy it.  All we had to do was promise to mortgage our entire country to them and move all our industry to China so we could be entirely dependent on them and they could own us.  What could be better?

China did this ‘owning’ by purchasing Treasury Notes, Bills, and similar government debt instruments; along with the occasional investment into corporate debt and a minor disaster in mortgages and U.S. Financial companies such as The Blackstone Group. From:

Demand for the relative safety of Treasuries has been supported in the past two years as finance companies reported $1.2 trillion in credit losses. China boosted holdings of government debt as it lost of more than $5 billion from investing $10.5 billion of its reserves in New York-based Blackstone Group LP, Morgan Stanley and TPG Inc. since mid-2007.

But the recent tendency for the U.S. Government to print print money with wild abandon and to assume that China will buy all the debt we can print has been noticed by the Chinese, who are getting more than just a bit worried (same source):

China, the U.S. government’s largest creditor, is “worried” about its holdings of Treasuries and wants assurances that the investment is safe, Premier Wen Jiabao said.

“We have lent a huge amount of money to the United States,” Wen said at a press briefing in Beijing today. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

And further down they look at just: How’s that work’n out for you?  on those investments in Chinese Yuan terms:

Treasuries have handed investors a loss of 2.7 percent in yuan terms this year, according to Merrill Lynch & Co.’s U.S. Treasury Master index. Chinese investors increased their holdings of the bonds 46 percent to $696 billion in 2008, according to U.S. Treasury data.

“Of course we are concerned about the safety of our assets,” Wen said after the annual meeting of the legislature. “To be honest, I am a little bit worried.”

So China would have been better off holding their own pieces of pretty printed paper rather than our U.S. Government Treasuries. Hmmm.  And they know it.  Hmmm.

This will constrain what the U.S. Treasury can do, since China is the biggest source of funding for the U.S. Debt Machine; and they are catching on to the “issues” pretty darned quick. Again, from the same source:

China should seek to “fend off risks” as it diversifies its $1.95 trillion in foreign-exchange reserves, Wen said. Yu Yongding, a former adviser to the central bank, said in an interview on Feb. 10 that the nation should seek guarantees that its Treasury holdings won’t be eroded by “reckless policies.”

Mr. Obama:  it’s pretty bad when The Chinese Communist Government has to give you lessons in Capitalism and preservation of a sound currency. So you have a choice: Accept that China “owns our ass” and go begging to them for more, please; or burn them with your present spending plans loaded with “pork barrel spending” and socialist programs (expansion of every entitlement known to Democrats).

I’m betting on “burn ’em” by inflating away the value of those $Trillions we owe.  So what’s China thinking? (same source:)

The U.S. trade deficit and the government’s “nearly unrestricted” borrowing led to excess liquidity worldwide and “sowed the seeds” of the financial crisis, the People’s Bank of China said in a report today. The dollar has dropped 17 percent against the yuan since China ended a fixed exchange rate in July 2005. It was little changed at 6.8384 yuan today.

“China is worried that the U.S. may solve its problems by printing money, which will stoke inflation,” said Zhao Qingming, a Beijing-based analyst at China Construction Bank Corp., the country’s second-biggest lender. “If the U.S. can make sure this won’t happen, then China will continue to invest.” 

Notice that conditional “If the U.S. can”.  So we know they are watching, and they are not interested in handing more money to us if we keep spending like a drunken sailor.  And our present course of action is spending more than a drunken Navy (and Air Force, and Army, and… ) could possibly do in a year of shore leave.

Chinese plans? (same source:)

Wen reaffirmed China’s target of an 8 percent expansion in 2009 as economies from the U.S. to Japan contract, saying the goal was “difficult but possible” to achieve.

So it’s a slow down, but still an 8 percent growth. Growth of a large economy takes resources. Metals, coal, timber, food, cement.

Delegates of China’s legislative advisory body suggested that the government diversify away from Treasuries into more risky assets. Jesse Wang, executive vice president of China Investment Corp., said on March 4 that the nation’s $200 billion sovereign wealth fund may invest in “undervalued” commodities.

And that is where they see value. So look to commodities and commodity stocks


Zhang Guobao, head of the National Energy Administration, said China should invest more in commodities instead of hoarding the U.S. dollar, the official Xinhua News Agency reported on March 7.

And I must agree with their conclusion:

China’s trade surplus has all but evaporated, eliminating the need or ability of China to purchase additional US debt. In addition, the Chinese have made it clear that their national interests are best served by diversifying into commodities and other real assets, the value of which is not contingent upon an overleveraged debtor nation.

End Game Clear

As long as China continues to purchase US debt, Bernanke is constrained from blatantly printing money. As China throttles way back on its purchase of US debt, America will have three choices – 1. Borrow and spend less 2. Raise taxes tremendously or 3. Print money. Based on what we have seen so far, it will be some of number 2 and a lot of number 3.

The odds are that China will ultimately get its money back, but the value of what they receive will be far less than what they gave.

So where does that leave us? With a U.S. Dollar that is almost certain to head down in value due to inflation; with a growing Chinese economy looking ever more to internal growth, and with a continuing growth of Chinese demand, especially for land, resources, commodities of all kinds.

This argues for a metals and mining resource sector advance and a drop in U.S. Treasuries over time (along with the dollar dropping against other currencies, especially those with a resource base such as Brazil, Australia, and Canada). European currencies are a different issue and will move in their own ways, but that will be a different posting…

So what does a metals, miners, and short treasuries race look like?

Metals, Miners & Short Treasuries

Metals, Miners & Short Treasuries

This shows a firm bull run started in copper and copper miners, silver and silver miners, gold, gold miners, the works. The only laggards are the platinum group where reduced auto demand means reduced catalytic converter demand; but this will catch up as industrial demand for catalysts in China and India resume and the general economy sputters back to life. So copper & silver now, platinum Real Soon Now.

It would be interesting to do a race of the major miners: BHP, RIO, RTP, etc along with the major mining economies (Brazil, Australia, Canada, Russia).

Miners & Mining Economies

Miners & Mining Economies

Remarkably similar with good “entry” calls from all the major indicators. Each individual chart ought to be inspected to confirm the indicators for each ticker before buying anything, but a rough ‘eyeball evaluation’ of the chart shows them all moving more or less together. BHP, RIO, RTP, and EWZ look to me to have the best “up tilt” recently with the least volatility, but a 3 month “race” would clarify that. The charts confirm the thesis. Metals and Miners are investable now.

Disclaimers, Disclosures, and Where To Get Charts

You ought to visit big charts where these charts are coming from, and try the advanced chart option on a few of your own stock tickers. It’s free, it’s easy, and it is valuable. My only relationship is as a satisfied user.

As we look at charts, if you want more detail on indicators, I have a posting describing them in more depth.

DISCLOSURE: I am long IAF – an Australian Fund; EWZ, PRB, CZZ, and BAK – all Brazilian stocks or funds; and long TBT – a “short U.S. Treasuries” fund. I also own some FCX and PCU – copper stocks, and some gold, silver, and platinum miners – SWC, GDX and will be buying a bit of PAL as a trade.

About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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