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Is China’s economic growth too good to be true?

A worker cuts reinforcing bars in a steel factory in Ganyu county, Jiangsu province. China is the world’s largest consumer of iron ore.


Money manager Jeffrey Gundlach believes Chinese economic growth figures are being faked to present too rosy a view of the country's prospects. It's a claim, that if true, would have major implications for investors.

In a recent conference call with clients, Mr. Gundlach, founder of Los Angeles-based DoubleLine Capital, took issue with official numbers from China indicating growth is running around 7.5 per cent a year – a rate that suggests the world's second largest economy is in decent shape.

Mr. Gundlach, a well-regarded U.S. bond fund manager who is never shy about saying exactly what is on his mind, isn't buying it.

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"I don't believe growth is above 6 per cent in China. I think that China is basically fabricating numbers, which they've certainly done in the past," Mr. Gundlach said.

Given what he thinks about Chinese growth, Mr. Gundlach is drawing the logical investment conclusions: He's bullish on bonds, bearish toward commodities, and short the Australian dollar.

"I'm liking bonds more now with prices down and yields up," he said.

In his call, he also expressed nervousness about the ability of U.S. corporations to maintain their high profit rates. He suggested placing a priority on capital preservation – an admonition against trying to swing for the fences with risky holdings in the current environment.

His evidence on Chinese growth being overstated is circumstantial, but plausible.

Exhibit No. 1 is the trend in iron ore prices. The recent spot price for imports into China was $118 (U.S.) a tonne, down from a high of $158 a tonne in late February. China is the world's largest consumer of iron ore, a critical component for making steel, used in everything from automobiles to railway tracks. If prices are slumping, the most convincing explanation is that all is not well in key steel-consuming sectors of the Chinese economy.

Exhibit No. 2 is the Australian dollar, which is now worth even less than the swooning Canadian dollar. The Australian currency has been in collapse mode since January, falling 10 per cent to a recent reading of 95.7 cents (U.S.). Australia's export fortunes are obviously tied to China for coal, iron ore, and other raw materials, so a likely consequence of poor growth in the Asian economic powerhouse would be a weaker currency.

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Mr. Gundlach has been bullish on Japanese equities, but was surprised when the Nikkei blasted through what he thought was an aggressive target this year of 13,500, nearly reaching 16,000 last month. The Nikkei has since fallen back, but he advises patience, believing investors should use a Nikkei level 12,500 to 12,800 to take new positions. He says that after huge rallies such as the one the Japanese stock market has experienced in the last six months, corrections usually don't turn into collapses.

He suggests investors hedge any Nikkei exposure by being short the yen, which he believes could weaken from 97 to the U.S. dollar now, to around 200. "I obviously don't expect that's going to happen this week. In fact, it might take more than five years," he said.

His bullish bond call is based on a view that global growth is decelerating and inflation is low – conditions that favour fixed-income investments. World GDP growth was running at more than 4 per cent in 2010, and is currently just over 2 per cent.

As for stocks, Mr. Gundlach expressed concern that U.S. profits can't be maintained at their current lofty heights. Earnings are at their highest level in history as a share of GDP and 70 per cent above the post-war median, when measured as a percentage of economic output.

Mr. Gundlach believes there could be more downside to precious metals, with gold falling to $1,280 an ounce. But if gold gets that low – a drop of about 10 per cent from current levels – he believes it will mark a good entry point for picking up silver.

Mr. Gundlach has previously spoken favourably about silver, but he issued a clarification on the call. The reason he likes silver is its high beta, or tendency to move sharply relative to other financial assets. This means purchasers can get a lot of bang for the buck.

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Why own silver at all, if it may be vulnerable to more downside? Mr. Gundlach says it is a useful hedge to cover the risk that inflation might rise. Although inflation currently is well behaved, that might not always be the case, and given the metal's volatility, you don't have to own much to hedge the risk.

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About the Author
Investment Reporter

Martin Mittelstaedt has had a varied reporting career at the Globe and Mail, covering politics, the environment and business. He opened up the Globe's New York bureau for the Report on Business, and has also been on the banking and capital markets beats. He's written extensively on investing themes. More


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