Works eat lunch inside a subway tunnel under construction in Wuhan, Hubei province. Beijing has fast-tracked approval of infrastructure investments to combat slowing growth.DARLEY SHEN/Reuters
My Wednesday column outlined the theory that Chinese credit conditions are among the most important indicators for Canadian resource investors. With this post, I'll use data to bring the theory down to the level of tactical advice.
The first chart on the left compares China's year-over-year money supply growth (M2, in this case) to the year-over-year returns for the domestic S&P/TSX Diversified Mining Index.
The close connection is apparent – the r-squared has been 0.77 since the beginning of 2010. It's also clear that Chinese money supply growth leads mining stock performance.
Correlation, as commenters are fond of reminding me, means nothing unless there is a convincing subjective backing for the relationship. In this case, the subjective case goes like this: China expands loan growth which increases M2, the loans are used by Chinese companies to buy land and build things, which in turn raises commodity demand and raw materials prices.
China's money supply data is published monthly and is backward looking so its of little use to more tactical investors. This is why SHIBOR – the Shanghai Interbank Offer Rate – is important.
SHIBOR is published daily and provides insight into credit conditions. When SHIBOR rises, this implies credit is tight and loan growth declining. As our chart shows, it also suggests lower commodity demand and lower stock prices ahead for domestic miners.
The second chart on the lleft above illustrates how money supply growth and SHIBOR move in the opposite direction. The negative correlation is interesting for the entire series at -0.59 but not compelling enough to trade off of.
But this may change as credit stress in China increases. The People's Bank of China channelled the tough love program for the country's banking system in June of 2013 by not providing liquidity during an interbank credit crunch. This caused the spike in SHIBOR rates. At the same time, money supply growth drifted lower.
The past few weeks have seen stronger Chinese economic data which suggest the government is retreating from policies to promote credit reform. This is good news for Canadian resource stocks.
Canadian investors still need to follow SHIBOR rates closely. As long as they are stable or declining, investors can remain confident. Conversely, renewed government efforts towards reform will immediately be reflected in SHIBOR rates, and then money supply data, and then resource stocks if current patterns hold.
Scott Barlow