When China Sneezes, Mining Interests Around the Globe Catch a Cold

Markets reacted quickly this Tuesday after Chinese officials announced a drop in oil imports during the month of July.  Oil prices immediately headed south, dropping below $80 a barrel after reaching new three-month highs on Monday. 

Reliable economic data from the Chinese government is sparse, but when macroeconomic data is released that can easily be verified by outside sources, markets waste no time reacting to the portent of the message given.  The Chinese manufacturing engine has been in hyper-growth mode for years, and for those national economies or raw material industries that depend on a vibrant export trade to China, a hiccup in Chinese demand can cause an immediate decline in production efforts across the planet.

A case in point is Australia, whose economy has benefited greatly from exports to China while its mining and petroleum interests have spearheaded a positive growth story that other developed nations can only observe with admiration.  GDP growth was 2.7 percent in 2009 and shows no signs of slowing down in 2010 or 2011.  However, today's announcement from China had an immediate detrimental effect on the Aussie Dollar as presented in the forex chart below:


The trading day is not over and the AUD has already dropped 1.1% when a one percent change in a currency in day is a rare event.  Since the European debt crisis erupted in May, markets have been driven by fear and volatility, with secondary influence from fundamental data.  The market reaction today is more reminiscent of stable market behavior where fundamental economic, financial and political data hold sway when group psychology dominates the movement of prices in all markets.

China's General Administration of Customs stated that July imports rose 22.7%, down sharply from June's 34.1% increase, a signal that the impact of stimulus measures taken in various developed countries are fading and economic growth may finally be slowing in China, the world's largest energy consumer.  China's crude oil imports were 19 million metric tons, or 4.5 million barrels a day, in July, or 15% lower than the record 22.3 million tons recorded in the month of June.  On a year-to-year basis, July oil imports were also down 3.1% from the 19.6 million tons recorder last year in July.

China's GDP growth for the first quarter of 2010 was 11.9%.  However, equity analysts have suggested that the China economy is in transition.  Bank of America Merrill Lynch wrote in a recent report to their clients that, "China is progressing to the next leg of economic development; from export-led growth, which was followed by construction and investment-led growth, to now transitioning to consumption-led growth, driven by rising per-capita income.  Over the last decade, China went through a massive construction phase, and one of the best ways for investors to play that was through industrial metals — copper, nickel, zinc and iron ore all did extremely well."

These predictions are not new news.  Market prices may have discounted these facts in current prices, but the missing links have more to do with timing and degree of severity.  For these reasons alone, markets may have over reacted to today's oil report.  The market price for Rio Tinto stock, a bell-weather of the mining industry, has already fallen more than 3% in today's trading.  Proponents of a double-dip recession in the offing are being heard again, and investors have mixed expectations as to whether the Federal Reserve today will offer new stimulus measures to deal with the second largest energy consumer's sluggish economic recovery.

China imports for major raw materials dropped across the entire spectrum in July.  Iron ore imports may have grown 9% year-over-year, but steel exports dropped 19% as the government discontinued export rebates in that sector, another acknowledgement of a further slowdown to come.  China has grown its consumption of global coal production to a 50% share over the previous decade.  Nation's that heavily depend on their coal export trade, for example South Africa, Indonesia and Australia, should adjust their future projections accordingly.

Some analysts remain optimistic.  Commerzbank in Frankfurt noted, "Worries regarding a lasting weakening of demand seem to be premature.  The distinct decline of imports compared to June can be explained, on the one hand, with the record imports in the previous month. In addition, there was a pipeline explosion in the port of Dalian in the middle of July which temporarily affected imports."

General export data coming out of China remain stellar.  However, with economies in the developed world remaining stalled in mid-recovery, the demand side of the equation for Chinese exports would appear to be lacking, suggesting a slowdown at the very least.  Mining and oil imports seem to be the first sectors impacted by China's inevitable pull back.  Caution demands a readjustment in near-term expectations for foreign sales.