Don’t Give Up on the Red Dragon

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The rumors of China’s impending death have been greatly exaggerated.

Once again, China has reported a fairly decent economic data point – this time the manufacturing Purchasing Managers Index, a measure of health within the manufacturing sector. The index moved up to 51.8 for February, the highest reading in nearly five years. Anything north of 50 indicates a strengthening economy.

To long-standing China bashers, such data says nothing of importance. We hear the voices that claim China is on the edge of a financial crisis, but that has been just weeks away now for what seems like the last decade.

After numerous trips through the region, it seems that most Western analysts have an inaccurate understanding of the complexities of China’s economy, how that economy actually operates, the true size of China’s wealth and just how Chinese savers/investors actually think about saving and investing. Simply put, the Chinese mindset is very, very different from what we know in the West.

Thus, the new data are a sign that China’s economic health is fine and improving.

Now, don’t take this as a sign to rush into the Chinese or Hong Kong stock markets even though both are cheap by our reckonings. Rather, keep your eye on commodities. They could soon catch a tail wind, which would ripple through commodity currencies, most particularly Australia and New Zealand.

Thanks to China’s economic gravity, it pulls into its orbit all the global currencies that are strongly tied to the commodities that China consumes. China is now the world’s largest consumer of most commodities. For currencies, such as the Chilean peso and Zambian kwacha (copper), Colombian peso (oil), South African rand (gold), the Thai baht (natural rubber and rice) and others, they to weaken as China’s economy slows and demand for various commodities declines.

That’s set the commodity markets back in recent years. China’s government has purposefully slowed the country’s growth to the sub-7% range, aiming for quality over quantity. Many global investors were dismayed at this as they believed China must continue to grow at 8% or more to drive the commodities market.

We see it differently for a few reasons.

Who Will Benefit from China’s Rebound?

If China consistently manages GDP growth of 6% – 7% annually, keeps its focus on building its middle class (which is, or soon will be the world’s largest), and if it continues to enhance the earnings power of its middle class, China’s domestic consumer and service-sector growth will go a long way toward driving commodity demand. After all, China cannot produce enough milk, dairy, and a variety of other food and industrial commodities to satisfy internal demand. It must buy those products from countries that produce them.

The Australian and New Zealand dollars are particularly interesting in the above scenario because these two economies are crucial to China’s internal demand.

New Zealand, despite its diminutive size, is the one of the world’s heavyweight dairy producers. China relies on New Zealand for milk powder. China is also buying a large quantity of wood and meat as well. In total, China is the second most-important destination for New Zealand exports.

Australia, meanwhile, is effectively China’s personal Costco. The country ships to China everything from wool and gold to wine and iron ore – and just about everything in between. Indeed, Australia is one of China’s most-important trading partners in terms of products imported into China.

Thus, our positive sentiments for the two “down under” dollars.

As China’s economy continues to post decent growth, and so long as a U.S. stock sell-off doesn’t undermine the global economy, we would expect to see the Aussie and Kiwi dollars continue to methodically climb higher.

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