By Ben Strubel of Strubel Investment Management
In early May I wrote an article for our monthly newsletter (you can subscribe for free here) about why we don’t own commodities. In that article I said that while I thought the investment thesis of increased global demand for commodities was true, there was still a bubble as prices were far ahead of demand. One of the biggest drivers of increasing global commodity demand is China. So, let’s take a closer look at that demand.
Seth Klarman’s Collective Wisdom: Risk Analysis Is The Key To Investment Success
Please note this article is based on publicly available information, however ValueWalk just received Baupost's 2018 letter moments ago and will have exclusive coverage shortly. Seth Klarman is widely regarded as one of the best value investors the world has ever seen. Over the past few decades, his hedge fund, the Boston-based Baupost, has achieved Read More
Chinese Industrial Commodity Demand
|Commodity||Percent of World Demand|
(Source: data from Michael Pettis)
Chinese consumption makes up close to half of the world’s demand in many commodities that are used in the industrial and construction industries. What is China doing with all of these raw materials? The popular response is that China is building important infrastructure that will power the economy in the future: highways, railroads, airports, power plants, factories, and all the trappings of a modern industrialized country. But how much of that is really true and, more importantly, how much of what they are building is actually useful?
Much of the new construction has gone under or unutilized. Brand new cities, offices, housing, universities, and transportation sit empty. In fact, some have been empty for a decade. Some examples include the following:
- New South China Mall, the world’s largest mall based on gross leasable area, but 99% empty since opening in 2005. (PBS video: http://video.pbs.org/video/1218530801/)
- New Ordos, perhaps the most famous example of a “ghost city,” in Inner Mongolia has been empty since construction began in 2000. (http://www.time.com/time/photogallery/0,29307,1975397_2094492,00.html)
- Yunnan Universities New Campus, built for 2.3 million students, but housing only 11,000. (http://www.businessinsider.com/pictures-chinese-ghost-cities-2010-12?slop=1#finally-heres-a-giant-new-campus-for-yunnan-university-which-was-built-to-accommodate-23-million-students-it-has-11000-enrolled-19)
- Empty bullet trains and empty highways (http://www.slate.com/id/2291271/ and http://www.msnbc.msn.com/id/43378739/ns/business-world_business/)
- Excess production capacity in aluminum, cement, and steel.
In fact, China’s astronomical GDP growth has mostly been due to these types of fixed investments. Estimates of China’s fixed investment as a percent of GDP range from 40% to 50%.
The plan is that eventually this infrastructure and real estate will be needed by a rising middle class. But again, looking at the data shows a different story. Consumer expenditures in China, as a percent of GDP, have actually fallen from 46.4% in 2000 to 35.1% in 2009.
In fact, a McKinsey report on China says the following: “China has the lowest consumption-to-GDP ratio of any major world economy. What’s more, the consumption share has fallen by nearly 15 percent since 1990 despite China’s robust growth. The speed and magnitude of this decline are unprecedented in modern history. Even during the full-scale industrialization of the U.S. economy during World War II, American consumption never dropped below 50 percent.”
Also, the ratio of household income has fallen from 60% of GDP in 1992 to 52% in 2010 (compare this to Europe at 60%+ or the US at 70%+). Instead, corporations’ share of national income has risen.
Many claim that while China might be a bubble, the government will engineer a “soft landing.” However, the situation has gotten worse, not better as the years have gone by. Consumption and personal income continues to decline as percent of GDP, while more and more of the growth is tied to massive fixed investment projects that are becoming increasingly useless.
Looking at the data it’s no surprise that people like Jim Chanos are bearish on China and even former China bulls like George Soros have been changing their tune recently.