Thursday, 30 July 2015

China Growth Proxies: Aussie, Copper and VW

China´s nominal GDP growth has declined from a post-crisis (2009) level of close to 20% yoy to the recent low of 5.8% yoy in early 2015, according to the last CICC Macro Thematic Report. The government targets almost 10% nominal GDP growth, with 7% real annual growth. By contrast, a soft purchasing manager index (PMI) and another equity sell-off have reinforced fears of Chinese growth slowing down. The flash Caixin/Markit PMI released last week showed China's factory activity contracted by the most in 15 months in July; however, the official PMI stood at 50.2 in July, on par with the previous month's reading, according to the median forecast of 20 economists in Reuters poll.

Figure 1: China Growth, yoy, 2006-2015

What have the Australian dollar, copper futures and Volkswagen share prices in common? China. China´s linkage with the world economy is most directly read via demand-driven industrial commodities (copper, iron ore), market-determined China dependent currencies (such as the Australian dollar) and industrial goods that the Chinese like to and can increasingly afford (such as VW´s Audi cars). These asset prices can be taken as proxies for China´s growth.
China these days demands more industrial metals than the rest of the world combined. China´s industrialization and urbanization had created a super cycle in metal prices; with the new emphasis on consumption and services, this super cycle has probably ended. Still, short-term assessments about China´s growth prospects move copper futures and options contracts.
The Australian dollar (like the New Zealand dollar) is a flexible market determined currency, which has a high (ca 50%) beta to the renminbi (RMB). Several emerging-country currencies (which as a group had a 15-year low this week) will have even higher RMB betas; but their central banks intervene quite heavily on the FX markets.

Figure 2: Austral-Asian RMB Betas

Volkswagen depends on China for more than half its net profit and 71 percent of its free cash flow including income from joint ventures and royalties, according to auto industry analysts. Growing uncertainty over China has finally been weighing on Volkswagen shares. Half-year results show that weaker demand in the world’s biggest car market is already slowing the 89 bln euro giant.
If you believe (and many economists still do) that asset prices are leading indicators, a select narrow group of assets would provide information on China´s immediate growth prospects – the Australian dollar, copper futures, and, e.g., the VW share prices. If you think, instead, that China will defend its 7% growth target and soon start an upswing, you can consider the three assets as a great buying opportunity (and their prices as lagging indicators). Aussie, copper prices and VW shares are now caught in a nice solid downward channel.

Figure 3: Dr. Copper, 2011-2015

Figure 4: Australian/US Dollar, 2011-2015

Figure 5: Volkswagen Vz, 2015

Official Chinese macro data are routinely met with suspicion, especially by those foreign observers who think that government legitimacy is only supported by high growth and rising consumer wealth. Actually, sentiment about domestic economic conditions is nowhere in the world better than in China where 90% of the population consider the current economic condition as good, according to the Spring 2015 Global Attitudes survey released by the Pew Research Center. Although Pew Reseach doesn´t ask the Chinese about political (dis)satisfaction, the correlation between economic and political satisfaction is high; and political satisfaction nowhere higher than in Asia[1].
It would seem then that domestic assessments of China´s growth prospects are more upbeat than foreign (media, investors). To be sure, the foreign impact of China will morph as the People Bank of China is envisaging a wider trading band for the RMB, likely anticipating competitive depreciation as early as August. Historically, China has been very efficient to translate RMB depreciation into higher growth[2]

Time to go long Aussie, copper and VW?

[2] Rodrik, D (2008), “The Real Exchange Rate and Economic Growth”, Brookings Papers on Economic Activity, Vol. 2.