China’s Secret Crisis

Sean Brodrick By Sean Brodrick, Resource Strategist, The Oxford Club

Metals

Heading into the new year, Americans are generally feeling good about our economy and markets. But investors would be wise to keep an eye on what’s happening across the Pacific.

It could be good news for metals prices.

Here’s the crisis: China’s total debt surged to around $27 trillion this year. That’s about 260% of gross domestic product. And that’s way up from the 154% of GDP that it was in 2008.

That’s a massive buildup of debt. And it’s not just the intensity. As you can see from this next chart, other countries are cutting their debt as a percentage of GDP. China is going in the wrong direction.

Companies in China are carrying so much bad debt that banks are afraid to lend. This recently triggered a liquidity crisis that was solved only when the central bank injected $86 billion into the market.

This is a boiling pot that China is desperate to keep a lid on. And there are multiple ways this could end.

There is a big risk that big China investors are too scared to talk about. And that is that China’s economy could simply unravel. The concern is that debt will become too burdensome, and companies and the market will simply crash. Since China accounts for 25% of the world’s GDP growth, you can see why this may worry folks.

However, while that risk exists, it’s unlikely.

It’s far more likely that the government will choose the scenario that pushes pain off into the future. And that is Beijing could pump more cash into the banking system and pump more cash into public works projects.

There are telltale signs this is happening. For example, China’s steel output hit a two-year high in November. That’s not what you see when an economy is collapsing.

Now here’s the thing. Recently, China’s leaders talked down expectations for economic growth. The Chinese Academy of Social Sciences forecast 2017 GDP growth of 6.5%, down from 6.7% this year. That’s rip-roaring by American standards, but that would be China’s slowest growth in more than 25 years.

As a result, many China watchers think the government will tighten monetary policy in 2017. We’ve seen metals prices pull back from recent highs, as speculators think the good times are coming to an end.

They’re wrong. Dead wrong.

It’s not that the leaders in Beijing don’t want to tighten. They know the dangers of too much easy money. But can they run the risk of the economy stalling as indebted companies collapse?

They can’t.

So I expect that China’s growth will be hotter than expected next year. At the same time, I expect Beijing to issue arbitrary rule changes as it tries to keep a lid on its boiling economy.

So investing in China might be tough. However, there are some beneficiaries.

One is the U.S. consumer. I expect the U.S. dollar to remain strong while the yuan continues to struggle. That means stuff in China will be cheap. A happy consumer means good news for retailers too, by the way.

The other is industrial metals. I’ve written about this recently for Energy & Resources Digest. Copper, zinc, nickel, lead and more all had a great 2016. I expect them to have more good times in 2017.

Will a falling yuan boost gold prices? It hasn’t yet. But that’s possible, too.

Keep one eye on China’s economy. And keep another on the price of zinc, nickel, iron and more. If China’s leadership announces more infrastructure spending and/or more cash injections into the banking system, metals could enter the next stage of blastoff.

Good investing,

Sean