SA resource shares were the best performing sector on the JSE in 2022 but have since struggled, down about 17% year to date. Contrast this with financial and industrial shares, which are up close to 13% this year.
Metal prices have been under pressure, with platinum group metals (PGMs) hit especially hard, falling 40% this year. After initial concerns that the Russia-Ukraine war would lead to drastic disruptions in the supply of key metals such as palladium, the focus has shifted to worries about demand.
A sputtering Chinese industrial engine, which consumes more than three-quarters of most metals exported around the world, has failed to ignite demand despite the reopening of the economy.
Construction activity, linked to the property sector, has slowed dramatically, which in turn has reduced demand for metals like steel. To understand this dynamic one has to sketch out the role that property ownership has played in Chinese households ever since the country allowed private ownership of housing.
Not only does it provide the psychological benefits of owning one’s home, but the start of the Chinese housing boom has been a driver of wealth, which for many is their nest egg for retirement. For younger Chinese citizens it became a status symbol. Property also serves as collateral, which allowed them to obtain permits to travel out of the country.
Savings-rich households scrambled to buy properties off plan, providing cheap funding to property developers. Even local governments benefited by selling huge tracts of land to developers.
However, the imminent failure of property developer Evergrande and the woes of Country Garden, a property giant with four times more housing projects than Evergrande, has shaken faith in this asset class.
Chinese households have accumulated savings during the years of stringent lockdowns, but with consumer confidence at record lows and property prices heading south, they have chosen to pay down their home loans, which total over $5-trillion, and refrain from splurging.
It may come as a surprise to some that at close to 300% the Chinese debt-to-GDP ratio is higher than in most developed economies. While central government debt remains well contained, it is the financial health of corporates and households that is cause for concern.
If one lurking hole in household balance sheets wasn’t enough, there is another issue that has been rearing its ugly head of late. The much-maligned shadow banking sector has also shown signs of cracks. Shadow banks include trusts amounting to about $3-trillion, which sell investment products and lend to companies, and don’t have access to capital markets. The worsening property market has put pressure on the investments of these companies and led to some missing interest payments.
The Chinese government has made it its stated aim to shake the country’s label as the world’s smokestack, by moving up the value chain in manufacturing and focusing on the services industry. China is now the premier manufacturer of electric vehicles, with about 50% of global market share.
However, even the services sector has hit a speed wobble. This has hampered its ability to absorb highly educated graduates and pushed youth unemployment to 20%. To avoid any further embarrassment, the government has decided to discontinue publishing that statistic.
In addition, the US has put in place a series of incentives to lure manufacturing back to its shores, further diverting investment from China.
So weak has the Chinese economy been that even inflation has disappeared. While the major global central banks have been hiking rates to fight runaway inflation, China is experiencing a deflationary spiral. Producer price inflation has been negative, dragging retail price inflation down to zero.
The Chinese central bank is now trying to stimulate the economy by cutting interest rates, but its tentative cuts have done little to inspire wary consumers. Fortunately, the drip feed of measures to revive the economy seems to be accelerating. A reduction in deposit rates should see lower mortgage rates trickle through.
There are also a slew of new measures, such as a cut in stamp duty to lure buyers back to the stock market, and tax breaks on new vehicles. We now wait with bated breath for the Chinese authorities to unleash a proverbial bazooka by investing directly in key sectors to stimulate the moribund economy.
As the proverb says, it is always darkest before dawn!
• Rassou is chief investment officer at Ashburton Investments.
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