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

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“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.

Cheers.
Kris.

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

Kris Sayce

Kris Sayce

Publisher and Investment Director at Money Morning Australia

Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It’s where he shares investment insight, commentary and ideas that he can’t always fit into his regular Money Morning essays.
Kris Sayce is the Publisher and Investment Director of Australia’s biggest circulation daily financial email, Money Morning Australia.

Kris is a fully accredited advisor in shares, options, warrants and foreign-exchange investments.

Kris has more than fifteen years’ experience in analysing small-cap stocks. He began his career in the biggest wasp’s nest in the financial world — the city of London — as a finance broker back in 1995.

It’s there where he got his ‘baptism of fire’ into the financial markets, specialising in small-cap stock analysis on London’s Alternative Investment Market. This covered everything from Kazakhstani gold miners to toy train companies.

After moving to Australia, Kris spent several years at a leading Australian wealth-management company. However he began to realise the finance and brokerage industry was more interested in lining its own pockets with fat fees, commissions and perks —rather than genuinely helping out the private investors they were supposed to be ‘working’ for.

So in 2005 Kris started writing for Port Phillip Publishing — a company which was more attuned to his investment outlook.

Initially he began writing for the Daily Reckoning Australia — but eventually, took over Money Morning. It’s now read by over 50,000 subscribers each day.

Kris will take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money!

Whether you agree with him or not, you’ll find his common-sense, thought-provoking arguments well worth a read.

To have his investment insights delivered straight to your inbox each day, take out a free subscription to Money Morning here.

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(You can find a list of recent investment articles written by Kris at the bottom of this page.)

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11 Responses to “Why BHP Will Be the First Victim of China’s Economic Collapse”

  1. DM

    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.
    Cheers

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