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JP Morgan says ‘Buy China’, as coal stocks show economy slowing

Economic growth
By Paul Hodges on 12-Feb-2014

China coal Feb14China seems to be trying to tell the outside world something quite important about the impact of its economic policy changes.  But to judge by most expert commentary, the outside world is convinced they are bluffing.  Thus JP Morgan issued a Buy recommendation yesterday on the Shanghai market:

“Chinese stocks will probably rally as much as 20% as gauges of economic growth stabilize and valuations rise from historic lows.  We recommend a trading buy of China equities, based on seasonality and all-time low valuations. We expect a 15-20% market rebound in the coming weeks, once growth stabilizes due to seasonality and the market’s focus switches to structural reforms.”

But state-owned China Daily gave a different view from the prestigious Academy of Social Sciences the same day:

“Surging borrowing costs are threatening China’s economic growth this year.  With growth momentum already slowing, Chinese enterprises will find their earnings increasingly insufficient to cover the cost of debt, with loan rates now exceeding 9%.  The situation inevitably raises the question of how the credit-dependent economy can keep expanding at the current pace.  There’s a dilemma facing the central bank.

“If the People’s Bank of China maintains a tight monetary stance and loan rates stay high, economic growth will be constrained.  Cash-starved companies will result in a contraction in business activity, with the Purchasing Managers’ Index for manufacturing likely to slide below 50 in the second quarter.  If the PBOC loosens monetary policy to push down borrowing rates, it will have to achieve total social financing – a broad measure of liquidity – of more than Rmb 19tn ($3.14tn) to support GDP growth of 7.5%.

“But that amount of total social financing would represent 12% year-on-year expansion, much faster than last year’s gain of 9%.  An increase of that scale will cause massive macroeconomic risk,  because non-performing loans will pile up faster and the goal of reducing the economy’s reliance on credit-fueled expansion will recede even further into the distance.  To have more sustained and quality growth, we’ve got to let the growth rate go down.

“Yet another risk is the massive debt of local governments that rely on land as collateral. If there’s a setback in the property market and land values decline, it’s unclear how local governments can repay their debt, analysts said.  As of June 30 last year, that debt stood at an estimated Rmb 17.9tn.

“People always say China’s economic growth model is export- and investment-driven. But if you look at the data for the past two or three years, it is becoming solely investment-driven.  Exports in 2012 made a negative contribution to GDP growth, and if you deduct speculative funds disguised as trade payments, you’ll find that exports were a drag on growth again in 2013.  As the economy increasingly relies almost solely on investment, any slowdown in investment could curtail growth.”

And then, as if it wanted to ensure we got the message, it used the chart above in reporting on the coal market :

China’s drive to transform its economy, which includes reducing the role of energy-intensive industries and paring steel capacity, is driving up coal inventories at key ports as demand across a variety of sectors weakens.  Inventories at Qinhuangdao in Hebei province, the largest coal port in China, exceeded what’s widely viewed as the warning line of 8 million metric tons on Feb 6, which was a 10-month high, according to the China Coal Transportation and Distribution Association.

“The rising stockpiles indicate that downstream users at steel mills, cement factories and coal-fired power plants are reluctant to purchase fuel because of weak market conditions. 

“Inventories at Qinhuangdao usually hover around 6MT, but the figure has been rising in the past few months.  In the past three weeks, the figure soared almost 2MT, reaching 8.28MT on Sunday.  Inventories are also rising at the other three major coal ports in North China – Caofeidian and Jingtang (both in Hebei province) and the municipality of Tianjin.  Inventories at the four major ports in North China totaled 22MT by the end of last week.

“Given that coal fuels so many industries, weak demand for the fuel also portends a slowing economy.”

“Massive economic risk”, or “trading buy”?  Opinions really couldn’t be more opposite.

Time will tell if the outsiders know best – but the blog doesn’t believe that China’s new leadership are bluffing.