I'm in Shanghai as I type, and the "China
Miracle" is in full bloom. Few variables are more important in the world
of metals and mining investment than the strength and sustainability of the extraordinary
bull run the Chinese economy has enjoyed for years. So many pundits, critics,
and cheerleaders keep pouring out opinions on this question that they
saturate the news – but leaves no one the
wiser.
I'm sorry to say that, as arrogant as I am, I do not
have quite the hubris to tell you that I have figured China out and know what
is and will be. Certainty is not an option here, and if anyone offers it to
you, I suggest you check your wallet afterward.
But I can tell you that I've traversed China from south
to north, from east to west. I've spent days driving through the countryside,
passed through China's largest cities and smallest villages. I have seen a
China that is visibly, radically different than the China I saw for the first
time a mere six years ago. Ten percent growth compounded over six years is a
177% difference – and the reality behind such numbers is unmistakable.
Yes, there is still great poverty here and a lot of people living on a
subsistence basis, but this is not a poor country. The
fraction that has been lifted to middle class and above is enormous, and the
country's GDP is now the second largest in the world.
Shanghai itself may not be the financial capital of
China any more, as in a politically dominated economy like this, all the big
decisions get made in the political capital of Beijing, but the wealth here
is tremendous. The proliferation of high-tech buildings, modern housing,
shopping malls, expensive cars, and more defies belief.
But the real shocker is the modernization of small
towns and villages. Oxen have been replaced with tractors, rags replaced with
bright new clothes, mud brick and thatch replaced with real brick and glass
and electricity and satellite TV. The material improvement in the lives of
hundreds of millions of people is spectacular.
To me, the most important economic consideration is
that whatever the degree of misallocation of capital may be here, the
allocation of most capital is to infrastructure, factories, power generation,
mine development, agriculture, housing, and generally to durable and
productive assets. China is gearing up to flood the world with products on a
scale that could be an order of magnitude greater than what we've seen so
far.
What if the EU disintegrates and the US sinks back into
recession? What will China do with all its productive capacity then? Some
would be wasted – factories and luxury cars can both rust for lack of
capital to maintain them – but the productive capacity would still
exist. With the investment already made, my guess is that the cost of goods
manufactured in China would plummet. Particularly with so many state-owned
enterprises – for which jobs and production may become more important
than profit – selling at no profit would be better than shutting down.
The central committee may even see flooding the world with inexpensive
products as a way to help China's trading partners while helping themselves.
Is China in a bubble? Could the China Miracle turn into
a China Nightmare?
I suppose it could; some massive misallocations of
capital will certainly have to be liquidated. But a system that was already
misallocating capital to an extreme degree can see major improvement simply
by misallocating capital massively.
Remember that, unlike the US, the Chinese government is
not borrowing money to build a network of high-speed trains across the
country; it's paying for it out of excess savings. On the household level,
people who save 40% of their income every year could lose half their savings
and still have a lot more net worth than the average, highly indebted
American. And they'll still want new cars, or electric bikes, or even
airplanes (I'm told that civil aviation has been legalized in China).
By the way, the high-speed trains are linking more and
more cities and are seeing heavy usage. You don't have to drive out of the
cities to an airport; you don't have to be there an hour before departure
time; you don't need to spend hours making connections; and there are many
other advantages. Most critical is that the population density, I'm told, is
sufficient to make the thing turn a profit. Plus, where there's high-speed
rail, the regular lines are freed up for cargo only – and those trains
now carry cargo up to 200kph.
My point is that if China is in a bubble, and if it
does pop, this system will still be here, as will all the new highways,
houses, factories, etc. This is not a deeply indebted nation of lawyers and
hairdressers, but a cash-rich nation building up its productive capacity. If
growth here were cut in half, it would still be substantially greater than in
the US or EU.
What about social unrest? Well, that's one reason for
China to keep manufacturing, even if profit drops off, but my sense is that,
a few idealists aside, there is very little real pressure or even desire for
major reform. People can see that things are improving, and they just want to
improve their own lives.
What about China's military buildup and saber-rattling
regarding those islands it and Japan both claim? Well, I was having
dinner recently in a very large Chinese restaurant, where a large group of
people were making round after round of toasts. The strength of the
anti-Japanese sentiment that the alcohol loosened was astounding. Many
Chinese – even though few are left alive who witnessed it –
deeply, deeply resent Japan's invasion during WWII. But I haven't met anyone
here who wants war – they'd much rather just become richer than Japan
and show the world who is smarter and better.
Similarly, I'd have to say that there is some sense of
people here wanting to take over the world, but they don't want to conquer
it; they want to buy it. China wants to be an economic superpower and seems
prepared to remove any obstacles to that goal – including outdated
Marxist ideas.
Whether that's good or bad is an important discussion,
but it's not what we're here for today. The point for now is that all of this
is bullish for China's continued demand for raw materials, including metals.
One more factor I'd like to touch on is the question of
"internal demand" – are there enough people in China with the
money and the desire to buy the output of China's factories and keep the
economy here growing? I don't think so... not all of the
output of all of the factories. But reduced demand from the rest of
the world does not mean no demand, and
China's internal demand is certainly growing.
An anecdote: I happened to be near the famous Kumbum Monastery near Xining,
Qinghai, in western China, so I stopped in for a look. The ancient Tibetan
architecture and relics were fascinating, but I noticed that the biggest
gold-plated temple of them all was not ancient, but built five years ago. The
monks are re-paving the streets with heavy blocks of tight-fitting granite. I
saw – literally – piles of cash at the Buddha's feet and
elsewhere, as the throngs left their offerings. But I saw only one other
Westerner the whole day I was there. The renewal of this monastery is a
testament to China's capacity to spend internally.
New temple at the Kumbum
Monastery, home of the "yellow" branch of Tibetan Buddhism. If you
abase yourself 100,000 times, you can get a better life – but in your
next life, not this one. I don't know how much gold is on that roof, but I do
know that it's paid in full – there's no mortgage – and people
seem to have plenty more to give.
What I am trying to say is that China's economy may
slow, but I don't think it will dry up and blow away. There may be a lot more
correction in industrial metals in the near term, driven by lower demand from
China, as the growth rate moderates. There will certainly be an acute
downward plunge if or when we get another 2008-style meltdown. But mid- to
long-term, major demand is baked in the cake. There will be money to be made
in metals and mining for decades to come – and should we be so lucky as
to get a meltdown before the metals peak, what a fantastic buying opportunity
that would be.
We'll be watching to see how that unfolds and will let
you know when we see major turning points and buying opportunities.
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