Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Why You Should Sell Caterpillar Inc. (CAT)

Hedge fund manager and noted short seller Jim Chanos targeted Caterpillar Inc. (NYSE:CAT) on Wednesday, in a presentation given at CNBC’s Delivering Alpha conference.

Caterpillar Inc. (NYSE:CAT)Chanos argued that Caterpillar Inc. (NYSE:CAT)’s business is largely dependent on the Chinese construction boom. He also cited issues with Caterpillar Inc. (NYSE:CAT)’s accounting. China’s economy is exhibiting signs of a property bubble, and if that bubble pops, Caterpillar Inc. (NYSE:CAT)’s business could be devastated.

Caterpillar is dependent on China

Over the last few years, Caterpillar Inc. (NYSE:CAT) has been a tremendous performer. Since the March 2009 lows, Caterpillar Inc. (NYSE:CAT) is up more than 260% (in addition to a steady stream of dividend payments).

Most of that gain has been due to the Chinese economy.

Since the financial crisis, China’s economy has been consuming raw materials at a rapid rate. In November 2008, the Chinese government announced a massive ($600 billion) stimulus program. The result has been unprecedented infrastructure spending.

In 2010, China surpassed the US in terms of energy consumption and is on track to surpass the US as the world’s largest importer of oil by 2014. In addition to energy, China has been a big consumer of iron ore and copper. China surpassed the US in copper consumption back in 2002, and the gap between the two countries had been widening ever since. Over the last decade, China’s consumption of copper has increased by over 200%.

Caterpillar, as a maker of heavy machinery, has benefited from the commodity boom. As Chanos noted in his presentation on Caterpillar, 30% of the company’s revenue, and 50% of its profit, is tied to global mining capital expenditures.

China’s property bubble

But that commodity boom could be coming to an end. A growing number of economists and money managers have warned of a bubble in China’s real estate market, and if (or when) it bursts, it will devastate commodity prices and the companies dependent upon them.

Perhaps there is no better way to illustrate China’s property problem than to observe its “ghost cities” — enormous, seemingly abandoned metropolises.

Anyone interested in the space should watch 60 Minutes’ report on the phenomenon. The video footage of empty highways and shopping malls is reminiscent of a Hollywood apocalypse movie.

Famed economist Nouriel Roubini has said China’s economy is the biggest risk facing the global economy in the second half of 2013. He has been warning since 2011 that China was suffer from an “economic hard landing” as over half of its GDP has been going towards fixed investment — an unsustainable amount.

Other stocks that could crater

Of course, if China’s real estate market collapses, and it brings commodity prices down with it, it won’t just be Caterpillar that suffers.

In particular, Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) would be exposed to downside even more so than Caterpillar. As a miner, the company’s business is dependent on the market for copper, gold, and other minerals. As management admitted on the company’s last conference call, the Chinese economy “remains an important demand driver.”

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.