Basic Materials: A Real-Estate Cloud Over China

SECTOR OUTLOOK: Chinese real estate, a big driver of demand for industrial commodities, is likely to weigh on the country's GDP growth in coming quarters

Jeffrey Stafford, CFA 1 October, 2014 | 9:00AM
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Key Points

  • The basic materials sector continues to trade very close to our fair value at a median price/fair value of 0.98 compared with a market price/fair value of 1.02.
  • Improved headline GDP in China comforted many investors. It shouldn't have. While China's GDP figures don't yet reflect real estate's troubles, they are likely to soon.
  • Lower corn and soybean prices in North America will put some near-term pressure on crop input producers. The long-term outlook for these companies looks more promising given our view of food consumption in emerging markets.
  • Declining recycled fibre prices will probably result in further weakness in containerboard prices.

China’s Real Estate Slump

As China goes, so go many industrial commodities. The country consumes massive amounts of many globally fungible commodities, making China's economic activity—particularly its fixed-asset investment—a good gauge for commodity market health.

According to the consensus narrative, Beijing's recent "mini-stimulus" succeeded in pulling the economy out of a cyclical trough, as evidenced by the sequential uptick in GDP growth to 7.5% from 7.4%. Consensus credits infrastructure spending for the improvement, which offset a weak real estate market. Although headline GDP has improved, fundamentals have worsened. With physical capital that largely exceeds the country's needs across manufacturing, real estate and infrastructure, China doesn't suffer from a deficit of investment. Stimulus solves little other than the problem of politically unpalatable GDP figures. Meanwhile, it exacerbates China's far more serious problem: debt.

Contrary to the consensus narrative, real estate was not a headwind for GDP in the first half of 2014. Based on our analysis of China's fixed-asset investment figures for the first six months of the year, real estate added 3 times as much to GDP growth as spending on rails, roads, airports, water and pipeline transport combined. This is a function of how real estate's contribution to GDP is counted.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Anglo American PLC2,998.97 GBX-3.65Rating
BHP Group PLC2,145.07 GBX-0.32Rating
Rio Tinto PLC6,002.00 GBX-1.48Rating

About Author

Jeffrey Stafford, CFA  Jeffrey Stafford, CFA, is an equity analyst for Morningstar, covering agriculture and chemical companies.

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