China sneezes and mining companies catch a long and damaging cold; this corruption of an old adage has never been more appropriate. The combination of a weak global economy and slowing Chinese demand for raw materials is punishing mining companies and forcing many to drastically revise future capex forecasts and jettison non-core assets. Vale SA (NYSE:VALE) is a case in point. And assuming that the Chinese economy does not return to the strong double-digit growth of the last decade (few if any analysts predict it to do so), the readjustment could be a long and painful one. Here’s one way to position your portfolio for China, though, that’s flying under the radar.
Vale is the second largest mining company in the world (after BHP Billiton Limited (NYSE:BHP)), the world’s largest producer of iron-ore and the world’s second largest producer of nickel. Vale’s shares have taken a sound beating over the past two years at the hands of economic weakness and is responding to falling demand by selling off non-core assets (of which it has many) and significantly scaling back planned capital expenditures for the foreseeable future.
Recent manufacturing data from China suggest that economic conditions in the country may be improving. Nevertheless, significant doubts remain about the resilience and sustainability of Chinese growth. Analysts have raised concerns about the proportion of GDP growth fueled by investment alone and the potentially dire consequences of severe imbalances in the distribution of resources in the Chinese economy.
The longer such imbalances continue, the more painful a long-run adjustment to appropriate levels of investment-GDP ratios will be for the country. But as long as the Chinese government can delay such an adjustment, the country will benefit from its disproportionately investment-driven growth model. Vale will also suffer from the long-run adjustment away from investment as a driver of economic growth and, also like China, benefits from short-term government support of investment demand.
The combination of slowing Chinese demand and broader global economic weakness sent iron ore prices plummeting to under $90/tonne over the summer, from highs of over $180/tonne in 2011. Prices have since recovered to around $110/tonne but are unlikely to return to the frothy highs of 2011 any time soon.