The Chinese government announced Wednesday that large shareholders and corporate executives would be banned from selling stock for the next six months in what constitutes clear panic on the part of authorities. Canadian investors are reasonably asking how much of this anxiety they should absorb.
The link between China and Canadian investors is dominated by a shared focus on commodities, notably base metals. China is the largest source of demand for virtually every commodity on the planet and, despite the sell-off in resource markets, commodity-related companies still make up 31 per cent of the S&P/TSX composite index.
The link between the Chinese equity markets and Canadian equities is tenuous at best – the growth level of the mainland economy matters far more. So the important question surrounds the extent to which the extreme volatility in Chinese equity markets reflects underlying weakness in the economy.
China's government target for 2015 gross domestic product growth remains at a healthy 7 per cent, but the economic variables most closely associated with industrial metals prices are showing signs of severe deterioration.
The first chart, below, highlights the close relationship between the pace of China's imports and the year-over-year change in commodity prices. Year-over-year import growth has been more volatile than commodity prices but time and again, the lines converge and move together – not least because China's resource-intensive, construction-based economy makes it the world's largest importer of resources.
Imports have shown year-over-year declines throughout 2015, a clear sign of a slowing Chinese economy that contradicts the 7-per-cent GDP growth target.
The second, lower chart gets at the heart of the Chinese economic growth strategy: credit. In late 2008, the government embarked on a massive credit expansion to pull the country's economy out of the financial crisis-driven slowdown. This took the form of ordering banks to more or less hand out loans to any business that walked into their branches (particularly real estate developers) and, at the same time, the government accelerated an infrastructure growth plan that included airports, high-speed railways and roads. All of these projects boosted demand for raw materials.
After a delay, metals prices began climbing in response to this outsized demand and have continued tracking China's credit growth since. But like imports, credit growth has been on a steady downward trend and the financial losses from the equity-market meltdown won't help. And also similar to import levels, commodity prices have followed the credit data lower.
Canadian investors should not be tempted to add metals stocks in the current panic in Chinese markets. As Robin Bhar of Britain-based SG Commodities Research writes, "a sustainable recovery [in base metals prices] is unlikely in the short term given the immense macro uncertainties and in the absence of significant production cuts/closures."
In other words, buying metal stocks as a contrarian now is what market insiders would call trying to catch the falling piano.
The upheaval and frantic government response to the sell-off in China may also represent a sign that the economy is weakening despite that 7-per-cent GDP target. A closer, more skeptical eye may be required with China's economic data in the future.
Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at Inside the Market online. Subscribe to Globe Unlimited at globeandmail.com/globeunlimited.
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