Buried within the release of China's leading economic indicators is possibly the best forward-looking signal for Canadian mining stocks.
China's Leading Economic Indicator Index, released Wednesday, is composed of five major components including the Hang Seng Mainland equity benchmark, industrial sales, fixed asset (infrastructure) investment, foreign direct investment and money supply growth. It is the last of those – money supply growth – that has shown a remarkable ability to predict the future course of Canadian mining stock performance.
The accompanying chart (to the left) highlights the close relationship between Chinese money supply growth, the majority of which is reflects bank loans, and the S&P/TSX Diversified Mining subindex. On five occasions – June, 2002; August, 2003; September, 2008; September, 2009; and November, 2011 – the year-over-year change in Chinese money supply predicted a major market move for Canadian mining equities.
The relationship makes economic sense. A significant increase in China's money supply usually occurs as a consequence of government policy designed to increase loans for new construction. The flurry of new building results in greater demand for inputs such as iron ore, copper and steel. That increases commodity prices and, hence, profits for Canadian miners.
The current state of money supply growth suggests that demand for metals is improving, but that the Canadian mining sector as a whole is fairly priced. Given the predictive power of Chinese money supply, Canadian investors who want to know where the sector is headed next should pay close attention to the next report.
Scott Barlow