5 money moves one China bubble-buster is making
Record art prices, empty shopping malls are clear warning signs
SAN FRANCISCO (MarketWatch) -- Investing’s holy grail, spotting a bubble before it busts, may be two parts science, one part art and a large dose of luck.
In the brew concocted by Vikram Mansharamani, a former private-equity investor and current Yale University lecturer who recently penned a book on the subject, a range of hard and soft indicators from ballooning credit to record art prices have been raising Chinese bubble flags for the past year.
But he has some ideas on where to find refuge if the Chinese growth engine slows from around 9% to 4% -- his projection for the country’s average growth rate over the next decade.
“I’m not optimistic on commodities, commodity countries, and anyone supporting the investment boom in China,” he said.
Yet a longer-term view that certain natural resources are facing tight conditions makes him favor a certain breed of commodities investments, namely those that promise payouts further in the future because of untapped reserves.
“Emerging markets will continue to grow. They may grow at slower rate than people think, but as they grow, demand for oil will rise and we will see signs of supply struggling to keep up,” he said.
Peaks and panicMansharamani, who is teaching a course at Yale on — what else — spotting the next market boom and bust, is first and foremost worried that China is on the same unsustainable run that took U.S. home prices, Internet stocks and Japanese equities to peaks and then panic.
As he wrote “Boombustology” in the summer of 2010, he looked at indicators from the number of empty shopping malls in China to record prices fetched at art auctions (some jacked up by wealthy Chinese buyers) and the building of new record-high skyscrapers. In past booms, he says, such gauges have signaled a coming bust.
“My single biggest fear is that China will be dramatically slowing, and with it will expose significant overcapacity in industrial commodities” and emerging markets, he said.
Since Mansharamani first spoke to MarketWatch for this article in October, plenty of indicators have shown the Chinese dragon is starting to look a little piqued. Related stocks and commodities prices have already fallen hard.
Chinese manufacturing surveys from November showed the sector slipped into contraction, the weakest readings since 2009. In late November, the People’s Bank of China appeared to respond to possible strains on its economy by cutting a requirement on bank reserves. Read more on sharp deterioration in business conditions and Read related item on China easing on the Tell blog.
Loosening of credit “is the biggest admission of a weakening economy that any country can give,” Mansharamani said in a mid-December interview. “I think my thesis is playing out.”
And the Shanghai Composite (CN:000001) has dropped to 2009 levels, setting off alarm bells among U.S. and European investment strategists who view it as a bellwether for Chinese growth. Read more on Shanghai Composite's drop.
1. Short global supply companiesIf these data points are only the start of a more profound retreat, global shipping companies are particularly vulnerable, Mansharamani said.
That’s because the industry is still adding new capacity as it fulfills orders made when global growth and shipping demand was on a tear.
A sharp cooling in Chinese growth could ripple across the global supply-chain industry, from banks that supply trade finance to port operators to logistics firms.
“Anyone involved in feeding the investment beast in China will be seen as having too much capacity,” he said.
The industry is already suffering. Some fear many companies could be forced into bankruptcy if China growth slows abruptly.
In November, oil-tanker operator General Maritime Corp. (US:GMRRQ) filed for Chapter 11 bankruptcy protection, citing a drop in tanker rates. Shares of shipping operator Frontline Ltd. (US:FRO) have sunk 84% this year. DryShips Inc. shares (US:DRYS) have fallen 60%. Read WSJ story on General Maritime.
2. Short industrial metals and their producersChina this year accounted for more than 50% of world demand growth for aluminum, copper, lead, nickel and zinc, according to Bank of America Merrill Lynch. Not surprisingly, a halving of its growth rate would also further depress prices for these metals — and their producers.
Already, copper’s 24% drop since July has been flashing red flags about the global economy.
Shares of big metals producers such as Freeport McMoRan Copper & Gold (US:FCX) , U.S. Steel Corp. (US:X) , Rio Tinto (US:RIO) (AU:RIO) and Vale (US:VALE) have lost about a third or more of their market value this year — compared to a near-flat showing for large U.S. stocks.
“I’d be cautious on industrial commodities for which supply constraints don’t seem as tight,” he said.
What’s made Mansharamani so worried about China?
In addition to some basic economic measures, such as how plentiful credit is, Mansharamani also looked at indicators that suggest extreme overconfidence.
The art market is a great prism for clusters of wealth among certain groups, such as Russian oligarchs in the last decade and U.S. Internet investors in the 1990s or Japanese business executives in the 1980s. Auction house Sotheby’s (US:BID) stock price has risen and fallen with each of these trends, he notes. In April, shares topped $55, a stunning nine times above its March 2009 lows.
In March, Asian art week in New York brought in a record sum, stoked by competitive Chinese buyers.
“When you hear a lot about world record art prices, beware, that’s unsustainable,” Mansharamani said. Read feature on China’s art-market boom. While Chinese are still flocking to art and wine auctions, prices aren’t hitting new records. Read WSJ wine blog article .
Brazil in the third quarter shocked some investors when economic growth braked. An iShares exchange-traded fund that tracks the Brazilian market (US:EWZ) has slid 25% this year. The real (US:USDBRL) has dropped 12%.
Australia’s economy looks particularly vulnerable because a China-spurred natural resource boom has had a spillover effect into the jobs, housing and banking markets, Mansharamani said.
“If China slows, mining companies slow down the need for people; what happens to the housing market and the banks that hold the mortgages?” he asks. Read related feature on dangers facing Australia housing market.
4. Go long oil Mansharamani’s got a view that oil and food, over the long-term, will face tight supplies conducive to higher prices.
With that in mind, companies that are sitting on a large resource portfolio rather than already producing -- or getting ready to tap reserves -- at a rapid clip are best positioned.
“The market overestimates the value of high-production companies in both fertilizer inputs and oil,” he said. “I believe you want to own companies with high reserves that look cheap on a reserve basis.”
Anadarko Petroleum Corp. (US:APC) , for instance, has a exploration portfolio whose resource size, relative to the size of the company, rivals that of oil majors like Exxon Mobil Corp. (US:XOM), according to oil-stocks analyst Michael McAllister at Sterne Agee & Co.
Noble Energy Inc. (US:NE) also has a comparatively large resource portfolio, McAllister said; he has buy ratings on both.
5. Buy agricultural stocksA long-term bullish view on global demand for basic commodities also makes Mansharamani positive on agricultural investments, such as fertilizer stocks and food producers.
Key factors that government food supply — such as water and fertilizer ingredients — risk severe constraints.
“In the next 40 years we may see peak potash,” he notes.
Plus, even if China slows to an average 4% growth a year, that moderate increase in wealth means a growing number of families are able to spend more on food.
“With a little bit of growth, you can put meat on top of your rice.”