- Money Morning Australia

Why BHP Will Be the First Victim of China’s Economic Collapse

Written on 06 January 2012 by Kris Sayce

“Land sales slowed sharply in China last year, according to a series of industry reports that highlight the deepening woes of debt-laden local governments that depend on land auctions as a crucial revenue source.” – Financial Times

The news isn’t getting any better is it?

In a moment we’ll show you why it’s still not too late to make a buck from China’s economic collapse using BHP. First, a refresher…

China’s Big Economic Problem
Falling land sales and falling land prices is a big problem for China.

Remember that much of China’s regional building program is paid for by selling bonds against land. It works something like this…

Chinese local governments sell bonds using land as collateral. The local government then uses the proceeds to build such things as sports stadiums, skyscrapers and swimming pools.

The bond buyers are assured they’ll get their money back because… well, property always goes up… and heck, look at the magnificent buildings… in the middle of nowhere!

Revenue that is generated from sporting events, leasing office space and swimming entry fees is used to pay the coupon on the bond. Eventually the bond is repaid when it reaches maturity (after say, 10 years).
Either the bonds are paid from the massive revenues made from these buildings (not likely). Or, as in all speculative Ponzi schemes, from the sale of other over-priced land.

In other words, China’s economy is built on two sets of foundations. Both equally as weak as the other: Western consumer credit (which we wrote about in yesterday’s Money Morning article The Sun Starts to Set on China’s Economy), and land speculation.

Both of which are certain to go bust.

So, how can you capitalise on this?

You could do a lot worse than keeping your eye on BHP Billiton.

BHP Tied to China’s Economy
So much of BHP’s revenue and profits rely on China’s economy. Its fortunes are completely linked to it. The chart below shows how close the link has been since mid-2008 (Shanghai Index – blue line; BHP share price – red line):

Shanghai Index - blue line; BHP share price - red line
Click here to enlarge
Source: Google Finance

News agency AAP reported last August, “Around 30 per cent of BHP’s business comes from China in the form of iron ore exports, a relationship which largely shapes Australia’s reliance on the Asian economic superpower.”

Dow Jones Newswires reported on Wednesday:

“Chinese copper smelters have settled copper processing fees from global miner BHP Billiton Ltd (BHP) at a lower level in 2012 compared with 2011…

“The processing fees, known as TC/RCs, were settled at $60.50 a metric ton for treatment charges and 6.05 cents a pound for refining charges, well below 2011 first-half TC/RCs of $72-$77/ton and 7.2-7.7 cents/lb as well as second-half TC/RCs of $90/ton and 9 cents/lb…”

Material companies that rely on Chinese trade turn down when the Chinese economy slows.

BHP has more than 30% of its business at risk on China. For the past four years, however, BHP shares have behaved as though 100% of its business is with China.

Simply because China’s influence on BHP reaches further than just the company’s direct trade…

It also relies on the trade between Rio Tinto and China… Brazil’s Cia Vale do Rio Doce and China… And Fortescue Metal and China.

Put another way, even though only 30% of BHP’s business is with China, the only thing that matters to investors is… that’s right, China.

BHP Our Stock of Choice
If you’re bearish on China’s economy like we are… you should probably be bearish on BHP… like we are.

But even though we’re convinced the Chinese economy will eventually collapse into a painful recession, we’re not saying it will happen right away. And it won’t mean BHP (or RIO and Fortescue) shares will fall in a straight line.

Experience tells us the market has a habit of grasping at straws and false hope. That’s where you’ll get short-term rallies even though the longer-term trend is down.

Yesterday, BHP shares closed down 1.1% at $35.82. Is that a significant level? We’re not sure.

Slipstream Trader, Murray Dawes loves shorting BHP.

But he got out of a short-term BHP trade a couple of days ago. The last we heard from him (he’s watching the market from Sydney this week, while your editor is keeping an eye on things from Gippsland) he’s waiting for the next chance to short BHP.

Our take on the chart is there’s a chance traders could push the share up by a dollar or so before it gets dumped again. BHP shares are volatile, as is most of the market, so anything could happen.


Related Articles

The Sun Starts to Set on the Chinese Economy
2012-01-05 – Kris Sayce

The Chinese Economy and Australia: the Last of the Bubbles
2011-12-20 – Kris Sayce

The Other Side of Short Selling
2011-09-14 – Aaron Tyrrell

Why China’s Quicksand Economy Will Sink Australia
2011-11-24 – Kris Sayce

From the Archives…

2011: What We Got Right. What We Got Wrong.
2012-01-01 – Kris Sayce

Speculators v Spectators
2011-12-31 – Kris Sayce

The Great Australian Housing Shortage?
2011-12-22 – Kris Sayce

For editorial enquiries and feedback, email moneymorning@moneymorning.com.au

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11 Comments For This Post

  1. SV Says:

    Kris, how does your bearish stance on China corresponds with the bullish one on gold? You site Chinese government and citizenry purchases of gold as a major pillar supporting gold price. Would not you expect this pillar to collapse if the Chinese economy goes down?

  2. Johnno McDoogle Says:

    I’ve been sitting back reading the constant BS published on this site for a while now it amazes me how you guys like to say we told you so about everything that happens, but when you actually read ‘what you told us so’ you hedge you’re bets so you can say i told you so either way.

    another great Joke, the market will go down but we’re not saying now and in a straight line, the market will go up but we’re not saying now or in a straight line.

    I t might happen in 3-5 years after rising to highs for an extended period at which you didn’t predict and you guys will be claiming we told you so!

    thats like me saying, you’re going to die one day it’s obvious and predictable but you’re timing is going to be way off the mark as it always is.

  3. Bob C. Says:

    Looks like you are under fire quite a lot of late Kris !

    My story is a bit more positive and is used here to provide support
    to yourself and your colleagues.

    I have been a regular Daily Reckoning and Money Morning reader for nearly 9 years now, both in the UK and here in Oz. Your track record has been outstanding to stay the least. You collectively saw what was coming and advised your ‘dear’ readers to invest accordingly, so I did. I bought into the gold bull market at around $350 per oz. and continued buying up to $1000, which included the proceeds of our UK property sale in 2007. We continue to keep a balanced portfolio of gold, cash, property (mortgage free) and some PM mining shares. The financial returns so far speak volumes, largely due to your carefully researched analysis. My wife and I maintain a cautious investment outlook. The current financial climate demands prudence.

    Here a few names Kris that I owe more than a bit of gratitude to;

    John Stepek and Dominic Frisby @ Money Morning UK
    Bill Bonner and Addison Wiggin @ Agora Financial
    Paul Tustain and Adrian Ash @ BullionVault
    Merryn Somerset Webb @ Money Week UK
    Doug Casey and David Galland @ Casey Research

    And of course you and Dan Denning, working tirelessly here in Australia to offer an alternative point of view.

    Well done to all of you – a big Hat Tip and many thanks for all the informative material you have published so far.

    Keep it coming !

  4. James Ciantar Says:

    Kris, are you going to trade BHP put options to make a buck on the China collapse ? If you think China will collapse by December 2013, then buy BHP put options, expiring at that time and watch your profits pile up as BHP’s share price plummets up to that time. Feasible for a small bet, unlike short selling.

  5. M&M Says:

    Welcome Johnno.

    Careful. Some might call you a shill.

  6. TRB Says:

    Time to buy BHP put options was last year around March April that was the time silver was hitting $50 a ounce.

    The MMR crowd was confident arrogant and foul mouth screaming hyperinflation.

    I was called shit for brains even challenging MMR naive way of market thinking .

    PF decided that maybe silver was a good buy after all it was hitting new highs, then a few days later silver crashed over 30%.

    In otherwords when bloggers become angry , arrogant,and the last bear throws in the towel beware a bear market is near.

    Same with the China story too much anger and pride.

    Pride always comes before a mighty fall!

  7. MG Says:

    Kris, Would Murray have done better shorting your stock buy recommendations from last year?? Just wondering is all…


  8. DM Says:

    Bob C @ 3
    Pleased to hear that you have done well over the last few years.
    I have a few questions, which I have asked several times without getting an answer.
    How do you store your gold? Clearly, you will have a significant stash if you bought some with the proceeds of a property sale between $350 and $1,000 an ounce. So I’m guessing you don’t keep it at home. If you store it with a “secure depository” (as I think is recommended by MM), what happens if there is a crunch and when you turn up to collect your gold, it’s gone? Does the organisation guarantee your gold will be there whenver you want it and do you trust this guarantee?
    Also, how much does the insurance and storage cost? Perhaps a rough cost per ounce, per annum would be sufficient.

  9. Bob C Says:

    Hi DM

    Your questions are very releveant.

    I store my gold the following ways;

    Safe Deposit Box in Bangkok (at my wifes bank, stored in her name, very minimal yearly cost)

    At home, approx. 30 x 1 oz coins

    BullionVault (look them up) – the majority of our bullion is stored with this company, via custodian Viamat in Zurich Switzerland. Monthly charges are small (pennies per oz per month) and neglible compared to our annual rate of appreciation. Paul Tustain is the CEO and I have spoken to him personally on a number of occassions as well as contact via email. The company won a Queens award early on for being innovative. Bullion is stored and allocated in our name (segregated). I am sure K Sayce knows about this mob, I have no problems putting my trust in this company.

    If there is a complete banking failure they cannot guarantee your cash holdings (Lloyds TSB) but in such an event your gold is guaranteed. I have been an account holder with them since 2006 and have been more than happy. Go to their website and look for yourself before you believe anything I say tho !

    BTW: The money we have made in Gold since selling our UK property would now buy back the same property 3 times over. Will we eventually get the same scenario in Australia – keep your eye on the Australian house price to gold ounce ratio. Currently it sits at something like 300 to 1, in the UK it is closer to 150 to 1. Has a way to go yet in this country, unless we have reached a ‘new normal’ :-)

  10. Peter Fraser Says:

    Good answer Bob.

  11. DM Says:

    Thanks Bob, great info. I’ll do some research but if I had gold, I think I’d like to have my physical gold in Australia but maybe you travel more than me and Zurich suits you.
    I also liked the analysis of the property price compared to the gold price, I have been wondering whether this was used by anyone.
    Unfortunately, property price records are only a very rough guide.


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