Hedge Funds Bet Against China

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It must be a lonely existence as a hedge fund manager. Depending on your area of focus, I wont call it expertise that depends on the manager. But by their very nature, many hedge funds make their money betting against the pack. Given enough time, betting against the pack in any remotely cyclical market which is most if not all means sooner or later, you will make good. But it requires patience, very deep pockets and committed investors.

Mark Hart of Corriente Advisors is one such person. Having made a fortune predicting both the subprime crisis and the European sovereign debt crisis, he now has a fund betting China is a train crash waiting to happen, according to a Telegraph article on the topic. The paper also quotes an unnamed academic saying: “Economists have contrarian views all the time. But these hedge funds have their shirts on the line and do their analysis carefully. The flurry of ‘distress China’ funds is a sign to sit up.

As a Bloomberg article explains, countries across Asia are attempting to grapple with accelerating inflation pressures as food and commodity costs climb and liquidity rises with an influx of foreign capital. Nowhere more so than China, where reserve requirements have been raised four times in the last two months and interest rates have been raised twice since October; the Shanghai Composite Index has fallen 13 percent over the last year due to fears that Beijing will slam on the brakes to control inflation. The article quotes Qu Hongbin, co-head of Asian economic research at HSBC in Hong Kong: “Beijing needs to act more decisively on policy tightening to stop inflation from accelerating too fast, he said, predicting at least 1.5 percentage points more in reserve-ratio increases within six months, and sees two quarter-point rises in the one-year lending rate, now at 5.81 percent. According to the FT, reserve requirements for the six largest banks in China will stand at 19 percent later this month, somewhere between Malawi and Tajikistan and nearly double the US’ 10 percent, or ten times Germany’s 2 percent.

Mark Hart’s point, mirrored by a growing band of “distress China” funds, is that China has been fueling a bubble for years. According to the Telegraph article, China has consumed just 65 percent of the cement it has produced in five years, after exports. The country is outputting more steel than the world’s next seven largest producers combined. It has 200 million tons of excess capacity. In property, it quotes Hart’s firm as saying it had found an excess of 3.3 billion square meters of floor space in China yet 200 million square meters of new space are being constructed each year.

Despite the vast population, the property is generally out of the price range for most, particularly in the eastern provinces. House prices are around 22 times disposable income in Beijing.

The wider fear, mooted often enough before, is that much of the $1.7 trillion loaned by China’s banks to local state entities is not commercially viable, like the inner Mongolia city of Ordos Shi, built for one million people, that is almost entirely empty. A TV report reveals empty streets, housing estates, shops and restaurants. But others disagree, saying China’s growing, urbanizing and gradually more affluent middle classes will fuel demand for decades to come.

So far, commodity markets agree with them. Iron ore is forecast to break $200 per ton next month on strong demand, a new high, and driven, supporters say, by surging demand for rebar (a key construction material.) Only time will tell who has the reading of the leaves correctly. China has consistently surprised on the upside in the past, but nothing lasts forever and China’s bull run will, given time, adhere to the rule too. The question is, when?

–Stuart Burns

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Comments (3)

  1. STEVEN says:

    Short sellers have been lucky because of US and their followers who alway think they are the best of all economics when they actually are not. China had studied, learned from their stupidity and most of all have standby precautionary measures. Because of these standby measures, the 1997 asian financial crisis will not happen again but even if it happen the damage will not be that serious. Good luck, shortsellers.

  2. Paul Adkins says:

    The action on housing development is in the 3rd and 4th tier cities. That’s where the demand is, and in those cities, the action is not in the high-end of the market, but in median urban apartments. Developers in one small city that I spoke to told me they can’t build the apartments fast enough.

    Quoting the Eastern seaboard as an example of how things are wrong in China is simply a waste of breath. As Americans of the 19th century used to say, Go West Young Man.

    Beijing is an established city, with some natural boundaries and practical limitations. It has mountains to the north and west, and is already so big that the sixth ring road is already being outgrown even though the road hasn’t been finished yet. It can’t grow much bigger, so naturally prices will rise, especially here inside the third and fourth ring roads.

    As for empty cities, I can show you photos of an empty city that I visited about 4 years ago. It was an eery sight, with brand new schools and hospitals and wide thoroughfares, but not a soul in sight. Now, it is a thriving metropolis, with almost 1 million people in it.

    Tell me, if you were building a brand new city, would you like to have people all around you, getting in the way, causing accidents, slowing construction down?

    Bottom line, the practice of building apparently empty cities is something that the Chinese have been doing for years, well before it came to the attention of a few western reporters.

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