There's increasing evidence that Chinese demand for commodities, especially thermal coal and iron ore, could slow in the next few years. Legendary short-seller Jim Chanos has made his opinions on China's seemingly insatiable demand for iron ore and coal well known. Over the last 12 months or so he's been proved correct, but few investors really understand why.
Put simply, China has been experiencing a boom in real estate construction. The reasons for this are varied, but include the fact that the Chinese leaders tend to aim for a certain rate of GDP growth, and fund the construction necessary to achieve that. This tendency is evident from the fact that net exports have been trending down as a percentage of GDP. The chart below shows Chinese exports of goods and services as a percentage of GDP, although if you believe Chanos' numbers (regarding exports of goods alone from 2007 – 2013), then the trend is much clearer.
Furthermore, capital investment (mostly in infrastructure and real estate) has been consistently rising as a percentage of GDP, meaning that a lot of the GDP growth is attributable to massive construction projects that are creating an oversupply, a.k.a ghost cities. Indeed, superinvestor George Soros has outlined his concerns regarding the poorly regulated debt that is fuelling this growth, known as the shadow-banking sector.
Asked at the 2013 Wine Country Conference about what Chinese companies are good to short sell, Chanos answered: "Property developers, banks, cement, and steel would be four places to start, or if you're afraid of doing that… then look at some of the leveraged iron ore miners." Put simply, he thinks that the real-estate oversupply must eventually be felt.
As Soros puts it: "The major uncertainty facing the world today is not the euro but the future direction of China. The growth model responsible for its rapid rise has run out of steam." China has used debt to build apartments and condos that are currently empty. China bulls say that migration will fill them, but this ignores the fact that it is the poor who are migrating – they can't afford the high-speed train, let alone a new apartment.
Meanwhile, BHP Billiton Limited (ASX: BHP) is of course publicly bullish about demand for the commodities it sells. However, that doesn't change the fact that it has been selling assets. Why would it do this if future demand is going to create scarcity?
The Wall Street Journal reported in October 2013 that BHP "signed an agreement to sell a coal mine in New Mexico to the Navajo Nation for roughly US$85 million, part of the mining giant's ongoing efforts to drive down costs and exit smaller operations around the world." In the same month, it was reported that Rio Tinto Limited (ASX: RIO) sold its half share in Australia's third biggest thermal coal mine, at Clermont.
More recently, The Australian reports that the "boss of BHP Billiton Coal, Dean Dalla Valle, has not ruled out divesting coal assets as he warned there was little sign of relief in the short term for the struggling sector." On top of that, The Wall Street Journal reported just last week that Rio Tinto "put stakes in several Australian thermal-coal mines on the block in sales that could fetch around US$3 billion, people familiar with the matter said."
Foolish takeaway
In my opinion, the worst commodity you can invest in is thermal coal, the type used for power generation. Even countries with very poor environmental stewardship, like China, are beginning to realise how damaging burning coal can be, both in terms of climate change and local pollution. Change will be slow, but the long-term trend is already clear – renewable energy and gas will provide a larger share of electricity in the future. For example, the Russians are planning to build a pipeline to deliver their gas to China, from 2018.
It's a pity that Australia isn't supporting our renewable energy industry to gradually replace coal mining, but such is the power of vested interests. In any event, Australian politicians can't change the fact that gas and oil are far more useful than coal. Oil is the clear winner in terms of cost/benefit analysis, and enduring demand – you still need oil to fuel an Army, for example, but you do not need thermal coal.
