Numerous anecdotal reports of a rapid slowdown in China's economy are now supported by surprisingly weak economic data. For Canadian investors, the continuation of this trend would put the final nail in the coffin of the commodity supercycle, so we'll turn to the best indicators of Chinese growth to gauge investment risks in the resource sectors.
The General Administration of Customs' report on trade activity was released Monday and it was awful. Imports, forecast to fall 10 per cent relative to 2014, came in much weaker at negative 12.7 per cent. That was bad, but export data were much worse. Chinese exports were expected to increase 9 per cent in year over year terms but actually declined at a 12.7-per-cent pace.
That said, there are reasons for skepticism where Chinese trade data are concerned. A later than usual New Year celebration may have crimped results. In addition, China's trade statistics have been distorted by cross-border asset flows as some businesses and wealthy individuals are widely believed to have used use faked documents to move money offshore in defiance of capital controls.
Economists have emphasized two indicators – total rail freight and electricity production – as providing the most accurate view of Chinese economic activity.
The two accompanying charts compare the two measures to the continuous commodity index. China is the largest source of demand for virtually every resource, and commodity prices are the primary way in which the Canadian market is linked to China's economic growth.
Correlation analysis supports a statistically significant relationship between rail freight and commodity prices. The connection would be much closer if not for the U.S. Federal Reserve's second round of quantitative easing beginning in 2010, which caused a huge, and in hindsight misguided, rally in commodity prices that was soon reversed.
Recent rail freight data support the thesis that the Chinese economy is in the process of slowing to a crawl. Year-over-year declines in rail freight activity are leading commodity prices toward financial crisis lows.
The relationship between China's electrical power generation and commodity prices is shorter, looser and choppier but unfortunately tells the same pessimistic story for commodity prices. (The same QE2-related anomaly is also clear.)
China is the biggest source of resource demand but not the only one – commodity prices are not going to zero. An acceleration in the U.S. housing market, for example, would provide considerable support for copper prices and other metals.
But the commodity supercycle that began in 2002 was driven by China's miraculous expansion and the construction and infrastructure boom that drove its economy. That investment theme appears done.
Despite the recent resource-related market carnage, energy and materials stocks remain 32 per cent of the S&P/TSX composite index. Domestic investors should consider an underweight position in these industries until a verifiable new source of global commodity demand arises.
Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at ROB Insight and Inside the Market online. Subscribe to Globe Unlimited at globeandmail.com/globeunlimited.
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