You may have missed it in all the excitement over Greece, but the Chinese stock market has crashed. The Shanghai Composite index is down 20% from its recent peak on 10 June, including a drop of 7.4% last Friday alone.
The index is still up 30% since January, thanks to a reckless share price rally fuelled by credit and monetary easing at the start of the year, but few investors are buying into the dips.
They think the correction has further to go, and that should spell bad news for investors in BHP Billiton (LSE: BLT) (NYSE: BBL.US) and Rio Tinto (LSE: RIO) (NYSE: RIO.US).
China Correction Or Crisis?
The China correction has partly been driven by a crackdown on speculation that has seen investors rush to take out loans to buy stock, allied to fears over the slowing economy, falling corporate demand, and overspill from Europe.
China’s central bank may have cut lending rates by 25 basis points on Saturday to 4.85%, but investors need more than that. The oil price has fallen on expectations of shrinking demand from one of the world’s major consumers, so how have BHP and Rio done?
Metals Sink
Since the Shanghai composite peaked in June, BHP Billiton is down 4.5% and Rio Tinto 3.5%. I would have expected worse, but I think the market had already accepted that the China growth miracle is over, as reflected in price falls of 26% and 13% respectively over the past year.
The iron ore price rally has lost heart, with the price falling to $60 a tonne, although that is still higher than April’s low of $47. Goldman Sachs reckons the price will fall to $50 next year, then slide towards $40. Copper has fallen steadily over the last year, from $3.2 a pound to around $2.6 today, a drop of almost 20%.
Brave New World
The price falls will be intensified by BHP and RIO’s joint strategy of ramping up production to drive out smaller rivals and dominate the market. This will certainly help them to grab share, at the cost of margins.
They are playing a long game and investors can afford to do so as well, with the stocks on fat juicy yields of 5.67% and 4.57% respectively. Trading at 8.12 and 8.42 times earnings, today is certainly a tempting entry point.
With Chinese growth set to slow, and the rest of the troubled world unlikely to pick up the slack, you have to accept the commodity supercycle is over. But then, so are the worst of the share price falls.
