What are the investment implications of a recession in China?

Posted on 12 June 2011 with 3 comments from readers

Doyen of market forecasters Marc Faber has recently voiced his support for short-king Jim Chanos’s view on China (click here), namely that the Middle Kingdom is facing a recession. The signs of an overheating economy are obvious, from soaring inflation to a runaway real estate market and urban congestion and empty property.

However, this is the world’s second largest economy. We saw in 2007-8 the global investment chaos that followed the subprime crisis and subsequent recession in the United States, the world’s biggest economy.

Inevitable cycle

So we cannot expect an easy ride if or rather when China tips over. No economy can grow as China’s has without eventually having a recession, unless the laws of market economics have been suspended, and the higher you grow the harder you fall.

Jim Chanos has been shorting Chinese stocks, although he is now complaining that it is impossible to find the stock to borrow to short, so popular has this trade become with Wall Street insiders. The next ArabianMoney newsletter will offer some ideas on how to do this with ETFs (sign-up here).

What are the wider implications of a recession in China? Basically all the areas of the global economy currently supported by Chinese economic expansion would go into reverse, at least for a period.

Industrial commodities are the most obvious asset class that would suffer. In the boom period China has been overstocking with basic commodities, so the existence of these stockpiles would accentuate the downturn to the negative.

Oil probably would be amongst the least affected by a recession as car drivers still tend to fill up, and the global supply position is partcularly stretched. But industrial metals, plastics and even agricultural commodities will take a big hit.

For contrarian minded investors this is going to be an opportunity to buy cheaply with the next boom in mind, for China will surely recover from whatever happens over time. And commodity investments still seem the best play on China as direct investment is rather difficult and foreigners always seem such easy meat for con-artists.

You also have to consider where Chinese money has been inflating asset values elsewhere and how these might change when Chinese become net sellers. Maybe Central London property, for example, or Asian art, or German car manufacturers.

Gold and silver

Precious metals are a much more difficult call. The Chinese are bigger buyers than India of gold right now, and there would be forced sellers in a big downturn. Silver would be the same or worse as many of the big speculators are in Hong Kong and Shanghai.

All the same, money liquidated from other asset classes might be rather quickly recycled back into gold and silver rather than kept in US dollars for which the Chinese have little trust.

For the rest of the world economy a recession in China would clearly not be good news either as China and Germany have been the main motors of global economic growth since the global financial crisis three years ago. Therefore, investors should also be selling out of other global financial markets as well if China is heading for a crisis.

One thing we would not advise is being slow to react to the prospect of a Chinese recession because the investment implications are severe and likely to be quickly discounted by markets as soon as they become apparent.