An end to the big red machine?

In the global arena of international trade, a weakening of a gigantic economic power would eventually affect all other major players, irrespective of how strong their economy may be or pretend to be. China, being a net exporter to sustain the North American consumers, would undoubtedly feel the pinch in the oncoming years, when consumers reign in their buying instincts and shun away from Wal-Mart. Indeed, the red machine is hitting speed bump and will halt sooner or later despite what other "experts" may say.

Big red machine hits speed bump

GEOFFREY YORK AND ANDY HOFFMAN

From Monday's Globe and Mail

October 12, 2008 at 10:45 PM EDT

BEIJING AND TORONTO — Less than two months after the excitement of the Beijing Olympics, the economic news from China has suddenly taken a turn for the worse.

Auto sales are slumping. The stock market is nose diving. Developers are offering heavy discounts to promote their unsold houses and apartments.

Even in an economy that is still expected to grow at an impressive 10 per cent this year, the hints of trouble are worrisome. And the problems are concentrated in industries such as construction and automobiles, which have major implications for the commodities that Canada produces.

The slowdown in China is already causing a drop in global commodity prices. This slump could continue for the next year or two, analysts say.

“When you add it up, it's bad news for commodity prices in the short term,” said Arthur Kroeber of Dragonomics, a research firm specializing in the Chinese economy.

“Commodity prices had unrealistically high expectations of Chinese demand built into them,” he said. “We had to have a correction. It will be really bad for the next year, as we see an unwinding of those unrealistic expectations.”

Shares of Canadian mining companies have been decimated in a matter of weeks on the sudden grim reality of falling Chinese demand for commodities. Teck Cominco Ltd., in the process of closing a $14-billion (U.S.) takeover of Fording Canadian Coal Trust, has seen its shares lose nearly a third of their value in a week.

“Everyone's mindset has been affected. This is the most severe thing we've ever seen. You and I have never seen anything like this. Basically, no one in the market has seen anything like it, “ Don Lindsay, Teck's president and chief executive, said in an interview.

The latest data from China are not encouraging. China's passenger car sales, which had grown by 18.5 per cent in the first half of this year, have now declined for two consecutive months. Sales fell by 6.2 per cent in August and a further 1.4 per cent in September.

The property sector is equally weak. Apartment prices have dropped by 10 to 20 per cent in many Chinese cities, and real-estate websites are filled with promotions from developers offering discounts to potential buyers. A leading Chinese financial magazine, Caijing, describes the nation's property market as “a grim scene of slow sales, price cuts and failed land auctions.”

The price cuts have been heaviest in southern Chinese cities such as Guangzhou and Shenzhen, where real-estate prices have dropped by up to 40 per cent in the past year. But even in Beijing, after the Olympic boom, preconstruction sales of residential units fell 76 per cent in September from the same month of last year.

The slump in auto sales and housing construction is having a serious impact on commodities such as steel, copper, iron ore and coking coal. Half of China's steel demand is derived from the property market. Copper wiring in new apartment buildings is a major source of Chinese demand for copper.

“If consumers sit on the sidelines for three months waiting for housing prices to drop, the short-term impact could be fairly severe as people try to clear inventories,” said Howard Balloch, a former Canadian ambassador to China who now heads an investment bank in Beijing. “There's a price correction going on, and core demand is slowing down.”

Chinese consumers are nervous about the market meltdowns and other economic trends, he said. “They're less willing to take on auto financing. They'll delay all sorts of discretionary spending.”

In the long run, however, commodity prices will be pulled back up by China's underlying trends, including the massive migration of rural people to its cities and the government's huge investment in infrastructure such as subways and trains, Mr. Balloch said.

China insisted Sunday that its “overall economic situation” is still good. “The economy is growing quickly and the financial sector is operating steadily,” the ruling Communist Party said in a statement at the end of a four-day meeting of its Central Committee. “The basic momentum of the country's economy remains unchanged.”

But the party admitted that “contradictions and problems” exist in the Chinese economy. “We must enhance our sense of peril and actively respond to challenges,” it said.

The growth of China's manufacturing exports has been slowing because of the weakening of U.S. demand. The Chinese government is trying to boost domestic demand by cutting interest rates, and Mr. Balloch predicts that it will take other measures to stimulate the economy.

Others are highly skeptical that the government will be able to counteract the effects of the U.S. slowdown and the global financial crisis. “The government can't just spend its way out of this,” said Michael Pettis, a finance professor at Beijing University.

“Many of the government's tools simply don't work any more,” he said. “My guess is that commodity prices will soften for the next two years. They were extremely sensitive to the high growth expectations.”

The unprecedented seven-year bull run in commodities, which has been a key driver of the strong Canadian economy, appears all but over.

Analysts are now ratcheting back their commodity price assumptions on the belief that a global economic slowdown will sap demand for resources such as copper, nickel and coal.

Canaccord Adams, a major player in the mining sector, particularly in the junior mining space, slashed 2009 copper price estimates last week from $3.34 (U.S.) a pound to $2 a pound, a decline of more than 40 per cent.

“Global demand is slowing and that includes China. The copper market and commodities in general have had a really good run here,” Canaccord Adams analyst Orest Wowkodaw said in an interview. “Unfortunately, we think we're going to take a pause in the sense that the consumption levels have to come down given the global slowdown we think is happening. The equities are being revalued as an investment class.”

In the hardest evidence yet of the slowing demand, Russian steel giant OAO Severstal last week said it is cutting steel production by as much as 30 per cent because of the sudden shift in industrial demand.

“Demand for all commodities has to slow if credit is tight. There is no way that investment and growth can continue in the levels that we've seen in this type of environment,” Mr. Wowkodaw said.