commodities | Whitburn

Paul Whitburn on the bulk commodities downturn in China and what this means for SA

The Chinese regulators’ crackdown on Big Tech – which has been intensifying since November 2020 – as well as the drastic measures taken by the country to move back towards a communist state has serious implications for the rest of the world, South Africa included. BizNews contributor Charl Botha spoke to Paul Whitburn, a Director and Portfolio Manager at Rozendal Partners, to get his perspective on the ways in which these developments in China – which is currently the world’s second largest economy – will affect the South African economy. Whitburn provided interesting insights, particularly with reference to the parallels that can be drawn between patterns in US history in comparison with China’s current communist moves. – Nadya Swart

Paul Whitburn on what’s been going on in China – economically and derivatively in the bulk commodities:

The Chinese market and bulk commodities is particularly interesting. I think it’s something that I’ve been looking at for a decade and probably been calling for the top of the Chinese property market for as long. But it’s interesting to look at the large property developers in China currently; and Evergrande is the largest property developer in China. And currently the stock has been completely smashed. Bonds are trading at 20 cents in the dollar and they’ve got serious liquidity problems at the moment. Not yet solvency problems, but I think that probably comes later.

And you’ve got to now take a step back and say, you know, is this finally the point where the Chinese infrastructure build and the Chinese building of residential apartments and all the rest of it comes to an end? And if that is the case, that would have huge ramifications for bulk commodities, specifically iron ore. As you know, all the growth of iron ore globally has come from China. We may see a little bit of the US come back with their big infrastructure bill, but – really – everything has been going through China.

And what we see today is; most guys are mining iron ore for twenty dollars and here in South Africa for forty dollars a ton, but it’s trading at close to two hundred dollars a ton in China. And, in all likelihood, that iron ore price should revert back to an incentive price, which we think is probably 70 to 80 dollars per ton. Now, if you assume that price with many of these local iron ore producers, I think shareholders would be in for a rude awakening if that comes to bear.

It’ll be interesting to see what happens in China because obviously everyone’s involved in terms of local government. The local governments get all their taxes raised by selling off land – and that’s their biggest tax income. There’s no property tax in China per say, so the question is; can these local governments then start charging tax on those properties to fill the holes? But this puts China itself, which has been on a gargantuan credit expansion over the last decade, in a perilous position at this point. So I think it’s interesting times ahead, for sure, for China.

On what China’s next move may be:

What they’ve done in the past is really set up sort of financial institutions and use their big banks to sweep the bad debts and problems under the carpet. I think what we’re seeing now with Evergrande, which is so large, [is] that it’s going to be very, very difficult to sweep it under the carpet.

So we’ve actually seen some strange moves where they’ve kind of gone to the bigger businesses that are very cash flow generative to ask them to buy stakes in underlying businesses. So Tencent was asked to actually bail out a subsidiary of Evergrande. You’re sitting in a communist state – people forget that – and they can tap anyone on the shoulder and say, ‘Look, we need some help to bail out this business. We need liquidity here. You’re very profitable. Could you help us out?’

So I’m not sure how they’re going to deal with it. It’s going to be very, very difficult because this has been a 20 year buildup, even 30 years. So, you know, this would be the first big drawdown in terms of capital fixed formation in China. And they will go through it at a period where their debt to GDP is also very high. So it doesn’t look like a very good outcome for them.

On Tencent donating almost $7bn to the public good:

We see it already because this week China raised the flag and said, ‘Look, you’re going to lose your tax incentives in China.’ So I don’t know if anyone’s noticed, but Tencent and Alibaba pay very little tax. You know, it’s between 10% and 15% tax rates, where the tax rate is close to 25% in China. So really, the government’s kind of said, ‘Those incentives will fall away. You’ll be taxed at the sort of normal rate.’

So I think that has already been set in motion. They understand that you can’t keep selling land to generate your tax revenue. They need to have more stable tax income. And why not? I mean, Alibaba and Tencent are wildly profitable. And they can call the tax rate, [to be] whatever they need. The thing about strong businesses kind of taking over weak businesses to help in the chaos is also not China specific.

I mean, I’ll just push you back to the US of A where you had many of the strong banks take out all those weak banks during the Lehman crisis. And then you had their great sort of capitalist society [which], essentially, nationalised Fannie Mae from shareholders at that point. So, you know, everyone is quite quick to point fingers at China, but the US itself probably did all the wrong things in that crisis, too, in terms of what they did to some shareholders in Fannie Mae and having the big banks, you know, help out and take over the weak banks.

On the bulk commodities downturn potentially having very negative consequences for South Africa:

Yeah, I think that’s largely correct. I mean, our biggest exports – PGM actually; China is obviously a large, large proportion of that, too. And whether the automotive market also rolls over in this is probably likely. But, yeah, we haven’t been partaking in this resource boom now. It’s largely been through price and not volume.

So we haven’t really built new iron ore mines or coal mines or PGM mines. It’s really just been the run up in price that has helped South Africa out. So certainly if those prices fall back, it wouldn’t be great for us. What impacts the rand and where the rand will be – that’s not something I know and certainly will not forecast.

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