Gold lost more than $50 an ounce this month, in large part due to worries that China will cool off its current torrid pace. Investors are concerned that the People's Republic of China's seemingly out of control growth will slowdown, raising fears of a hard landing reminiscent of the early nineties. Having visited China twice in the last six months and as recently as three weeks ago, such meltdown fears are overblown. Ten years ago much of China's east coast was still a backwater. However since 1976, China's real GDP growth has averaged 9 percent per year, or three times the average of major industrialized countries. So far this year, China's booming GDP grew by 9.7 percent in the first quarter, acting as a powerful stimulus to the world as both producer and consumer.
China's astonishing economic growth in the past has provoked dire warnings of the unsustainability of its economic boom. Yet year after year, the Middle Kingdom has disproved these naysayers.
China's booming economy is heavily dependant on natural resources
China is now the number one consumer in the world of copper, platinum, steel, zinc and iron. They produce more steel than the United States and Japan combined. And there are more cell phone users and beer drinkers than in the United States. The Ministry of Commerce reported that China's foreign trade this year will top $1 trillion this year, up 17 percent. While exports will be up 15 percent to $505 billion, imports will grow even faster to $495 billion, up 20 percent. In the fourth quarter of last year, China's imports reached $124.1 billion, up 42.3 percent. China is the fastest growing economy the world, and its voracious demand for everything from oil to copper is causing a spike in prices.
In 1997, Beijing's attempt to engineer a gradual slowdown caused a hard landing. Unlike then, the boom today is much more broadly based, particularly with a newly created middle-class exceeding that of the American population. The Chinese for example have introduced two "Golden Week" holidays a year, where the nation literally shuts down, allowing throngs of people to travel and spend. Beijing alone received 3.6 million tourists during the seven-day holiday. Chinese consumer demand, which is currently among the lowest in the Far East, is expected to grow significantly.
Indeed, it is China's push to boost its infrastructure, which is fueling a large part of its growth. Moreover the needed "slower" growth still means powerful economic growth (by western standards) and a continuation of the Chinese economy's insatiable demand for resources. China has boosted spending for steel, cement, roads and power facilities. To rein in this growth, capital requirements for new steel projects were raised to 45 percent from 25 percent and real estate projects were raised to 35 percent. The People's Bank of China raised its reserve ratio to 7.5 percent from 7.0 percent. These tightening measures are more of a signal than actual depressants to growth. Beijing has a major pipeline of investment and the Olympics are an excuse for this infrastructure spending. China's real problem is allocating its resources to where it needs it the most.
Over-investment in infrastructure
China is also in the midst of a massive investment spending cycle. The last bubble was in 1993-94, when year-to-year growth in fixed investment hit 60 percent. The fixed investment share of GDP was 43 percent in 2003. While fixed investment is growing due to infrastructure spending as a proportion of GDP, it was much higher in the past. Unlike the United States, which went through an over-investment boom in technology, China's over-investment in infrastructure is to accommodate the demands of a growing population. The situation is different from that of the early 1990s with free market reforms the key driver in the Chinese economy.
Demographics: Key Driver
Demographics are a big factor when talking about the China syndrome. China has the largest population in the world, with 1.3 billion people representing 25% of the world's population. China has over 30 cities with populations over 5 million, with Shanghai topping 20 million people, and Beijing with 15 million people. In its zeal for restraining its population growth, Beijing introduced a "one child" policy. There appears to be a skewing towards more boys and thus China's sex ratios are out of whack. This policy is apparently ending and there is believed to about 300 million non-reported children that may be added to the rosters. China has a young population and the addition of 300 million more, mostly girls, would correct an already skewed gender imbalance.
Simply, while China has grown over the past decade, there is room for more growth. Sure there will be short-term shortages but everywhere we went there was the recognition for more growth. This growth is needed to provide the millions of jobs that are required. Over 60 percent of China's labour force remains in the countryside but there is a steady migration with some 30 percent of the population now living in the cities. China must accommodate this growth with respect to housing, jobs, etc.
When they build, they do come
China's policymakers have embarked on meaningful economic reforms and in this case when they build, people do come. For example, in 1989, the total number of expressways (the size of the 401) in China was only 271 kilometers. Ten years later, China had over 1,000 kilometers of expressways and at yearend there was 30,000 kilometers of expressways. On this recent trip to China's coast, everywhere expressways were being built to link up the major cities. Beijing needs these highways since all were choked with speeding trucks and kamikaze drivers who do not respect lanes or other drivers. China hopes to have 82,000 kilometers of expressways, which will link most of its major centers. The problem however is once arriving in these cities, there still exists no easy way to move through the cities. Congestion is a problem, day and night.
The Power Crisis
China is also suffering a chronic shortage of electricity and plans to install 42 gigawatts of generating plant capacity this year alone, equivalent to the UK's entire installed capacity. Having flown, traveled by rail and car, we noted the need for more rail capacity since China's roads are already choked with trucks. The list goes on, including the need for additional port and shipping facilities, water treatments facilities and environmental infrastructure requirements.
Americans forewarned
Of more concern, as goes the Chinese economy, so goes America's financial markets. By becoming the world's largest debtor nation, America has unknowingly allowed itself to be governed by the newest superpower, China. China has immense reserves now, second only to Japan. With $400 billion of foreign exchange reserves invested largely in United States Treasuries, the Chinese have financed a large part of the American deficits. Should China slowdown or alternatively decide to dump its bonds in favour of gold or euros, it would throw American financial markets into a tailspin, causing US interest rates to skyrocket - and that is the Achilles' heel of the American dream.
America's budget deficit has been piling up, in part due to the war in Iraq. The war is harming the US economy, costing to date $200 billion and now Bush is seeking another $25 billion. Notwithstanding a stronger economy, the United State's current account deficit will exceed a record $500 billion this year. This means that every single day, the US must borrow around $1.5 billion from abroad to finance the huge gap between its imports and exports.
Be careful what you wish for
To date foreign investors, in particular the Chinese and Japanese, have financed America's twin deficits. However, having spent $137 billion on intervention this year, the Japanese did not acquire any US dollars in April for the first time in seven years, reflecting in part their own strengthening economy and stabilized currency. Moreover, the collapse in the bond markets prompted foreign investors to curtail their purchases of US debt with the realization that the Americans are pursuing a policy of currency debasement to pay off their debts. Yet this oversupply of US dollars is seeding a huge monetary expansion in China with the Chinese surplus piling up at more than a $100 billion a year as the dollar gets weaker, the Chinese economy gets stronger. Of concern is that by pressuring the Chinese for everything from the "peg" to trade irritants, the Americans risk the Chinese might follow the Japanese and other investors and begin to dump their dollars in favour of other instruments such as euros and gold - and that is the last thing that Bush needs now.
But all are not dependent on the largesse of banks. In Beijing, I met a number of dot com entrepreneurs, with one having recently completed a Nasdaq IPO. Indeed, there is a great desire for companies to tap the international markets for funding with more than 1,000 companies queuing to list on the Hong Kong Stock Exchange. Be ready for an invasion of Chinese companies, many of them with excellent prospects and surprisingly good balance sheets. Price-Waterhouse Coopers estimates that Chinese IPOs could raise $20 billion surpassing the US market this year.
China's golden opportunity
China is vast, not only in size and population, but also in mineral wealth. Mining has an incredible long history in China. Shandong province and Hebei province have been mining for thousands of years. By North American standards China's mines are small. Under the "Mineral Resources Law", all mineral resources of the People's Republic of China are owned by the State. Mining rights are allowed in a specific area for a specific time period and subject to the Ministry of Land and Natural Resources. China has about 1,000 gold mining operations, many of them owned by State agencies or geological groups.
China has become the world's fourth largest gold producer in the world. Shandong province is a major gold province that produced almost 250,000 ounces of gold last year. The largest mine recently went public on the Hong Kong Stock Exchange. Over the past few years the Chinese have deregulated gold exploration and mining activities. A "White Paper" was recently completed although that is not expected to become law until later this decade.
We recently visited a number of these gold mines in Shandong. Of interest is that China would benefit from Western technology and equipment since there has been little drilling. While there is evidence of much gold, little is known of the depth potential. Mechanized mining is unknown here. We believe that China will adopt further changes in order to develop its domestic gold mining industry.
China currently produces about 200 tonnes which matches its current consumption. Albert Cheng of the World Gold Council noted that the Chinese have about $1.2 trillion in savings but the country has one of the lowest gram per capita at 0.16 grams per capita in contrast to 0.73 in India and 1.41 in the United States. In the last couple of years, China has allowed its people to own gold and the Shanghai Gold Exchange is an avenue for its producers to sell production. Shanghai plans to offer gold futures to further stimulate trading. With a deregulated market and improving incomes, Cheng expects this level to rise significantly.
With China becoming such a big factor on a global scale, attention is being paid to its huge foreign exchange position. So far the Chinese have accumulated about 600 tonnes of gold or less then 2% of its foreign exchange reserves in gold. Given the development of China's national economy, we believe that China will moderately increase their gold reserves to 4-5% of reserves. Just to get to that level would require China to accumulate all the gold production for the next two years. In time, China would like to have reserves in line with their European counterparts, who hold 13% of their reserves backed by gold.
John R. Ing
Maison Placements Canada
130 Adelaide St. West - Suite 906
Toronto, Ont. M5H 3P5
(416) 947-6040
May 14, 2004
The information contained herein has been obtained from sources which we believe reliable but we cannot guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell for the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that Maison Placements Canada Inc. is to be under no responsibility whatsoever in respect thereof. Directors, shareholders or employees of this company may be beneficial owners of the securities referred to herein.