In China, it is now the Year of the Rat. I live in the city, where rats aren't so welcome, but in the Middle Kingdom the rat symbolizes a new beginning.
It's also the year of the Beijing Olympics, China's coming-out party for the world to see the ancient land's 21st century resurgence.
But as the Year of the Rat starts the new zodiac cycle, China's energy crisis is nibbling at Beijing's heels.
A see-saw of policy moves coming from the central government at the end of 2007 is playing havoc with China's consumer base, which is reeling from eleven-year highs in inflation. Food and fuel, of course, are the main pressure points of any modern economy, and when the Communist Party of China (CPC) moved last November to ease the burden on oil refiners, it upped the onus on Zhou Public.
China's crude oil refiners, many of which are headed by businessmen with major guanxi (the Chinese term for balance of favor and webs of influence, or, simply, "pull") in Beijing, have complained that government-imposed price caps on energy prices are squeezing margins to the size of a grain of rice as oil prices soar.
So Beijing responded in November with a 10% increase in prices for refined oil products such as gasoline, and China's new breed of motorists is feeling another pinch. November's year-on-year consumer price increase of 7% was the most in over a decade.
From bottom to top, China's economy needs the juice to carry it forward. Despite official pronouncements that coal is still king, you can't stick slag in the gas tank, and crude oil consumption stats bear out the country's increasing reliance on oil.
On January 14, the government-published China Securities Journal ran a pretty common headline on China's recent economic rise: "China Imports Record Amount of Crude Oil." Though crude oil output from China has increased by about 2% per annum over the past few years, an analyst with the State Information Center said, oil consumption grew by 200% more, or 6% per year.
What isn't so common is the 4.5% plunge in Morgan Stanley's China A-Share ETF (NYSE:CAF) we saw the next day, January 15. By lunchtime on Wall Street, the double-inverse UltraShort ProShares FTSE/Xinhua China 25 ETF (NYSE:FXP) had logged a 15% gain by betting on a correction.
Just take a look at the chart below, and note that this is reflects 3x average trading volume:
I told Wealth Daily readers about this play last week, and it's already bearing fruit. Interestingly, FXP plays the inverse of Hong Kong-traded "H" shares, not the more volatile Shanghai and Shenzhen "A" shares that CAF holds. But even the Hang Seng benchmark in HK seems primed for a downswing.
China Crisis Begins with Energy
As if to validate the thesis of this entire publication, China's energy and capital (shhh, don't tell them they're capitalists!) are linked like a finger trap, and they can't figure out how to decouple.
In 2004, the Asian Development Bank forecast that for every $20 increase in the price of crude oil on the world market, China would shed 1% of economic growth. What is not yet clear is whether that drop in growth will usher in a drop in energy consumption.
My bet is that it won't, and that all the millions of average Chinese (and perhaps hundreds of thousands of front-runners and identity card schemers) who have opened trading accounts in the past couple of years are feeling a lot poorer these days.
China is now over 30 months into a bull market, well past the statute of limitations for most equity surges. Just saying that there are a billion-plus people in the country won't prop up sky-high valuations indefinitely, and we're seeing air let out of that bubble now.
If air is similarly let out of the inflation bubble, some of the market slide will be tempered. Letting the national currency, the yuan, float more freely would help, but from prices to the paper people trade for products, Beijing has a heavy hand.
As the ADB forecast almost four years ago, when the Shanghai market was actually bearish, oil and Chinese economics are inextricably linked for the foreseeable future.
The next step is to strategize for the next Chinese bull market, which we at EAC expect will also be tied straight to energy. This week, a five year-old Chinese auto manufacturer called BYD Auto Co. is showcasing its plug-in hybrids at the North American International Auto Show in Detroit, alongside other models it hopes to debut for sale in China before the summer Olympics, and then in the United States in coming years.
We'll soon see how many auspicious beginnings are in store for companies in the Year of the Rat. Right now, though, the Chinese stock market is getting gnawed to bits.
Regards,
Sam Hopkins
www.energyandcapital.com
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