Why China’s slowdown could mean big trouble for Canada’s economy

By Andrew Hepburn - Friday, June 15, 2012 at 3:16 PM - 0 Comments

A vendor naps on a chair in front of shelves of steel commodities at a metal products market in Hefei, China. (Stringer/Reuters)

Former hedge fund researcher and commodities bear Andrew Hepburn looks at the potential implications of a widespread economic slowdown in the emerging markets on Canada.

A comforting narrative has emerged about our fair northern nation. It goes something like this: While the United States has been reckless in its lending, Canada is the smaller, prudent neighbour. So as the U.S. housing bubble burst and financial crisis ensued, Canada remained a well-regulated rock.

And speaking of rocks, the great northern land just happens to have the commodities required for the fast-growing economies of Brazil, Russia, India and China.

Time and again, Wall Street has pointed to these emerging market economies, the so-called BRICs, as the source of high commodity prices. Yet by now it’s very clear that China, along with Brazil and India, are slowing rapidly. Energy-rich Russia can’t be far behind if oil keeps falling.

China cut interest rates unexpectedly last week, signalling government concern that the sought-after soft landing of the economy is turning uncomfortably hard. As the Atlantic recently noted, many indicators of Chinese growth are flashing warning signs. Loan growth has collapsed, rail cargo and electricity output are sliding, and business sentiment has soured. India doesn’t look any better. Growing at close to double digits a few years ago, the country recently recorded a growth rate of 5.3%.

Prices are sliding: the benchmark Reuters/CRB commodity index, tracking a basket of commodities, is down more than 20% over the past year. Oil, copper and iron ore have all fallen substantially from their peaks.

Trouble for the BRICs means trouble for Canada, a major producer of natural resources. Whether it’s nickel in Sudbury or potash in Saskatchewan, our country has benefitted from the lengthy commodity boom that is now over a decade old. Alberta in particular requires lofty prices to make the oil sands economically viable. There’s also the tiny matter of the Toronto Stock Exchange, where energy companies alone represent 25% of the index.

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Turning water into money

By macleans.ca - Thursday, July 7, 2011 at 12:20 PM - 12 Comments

Dominique Favre/Reuters

Last month, Peter Brabeck-Letmathe, the chairman of Nestlé SA, the world’s largest food company, made a splash in Alberta for announcing, via an interview with Reuters in Geneva, that Nestlé was in talks with the Alberta government to establish a so-called water exchange—a market in which water, life’s sine qua non, could be bought and sold just like wheat, pork bellies or any other commodity. “We are actively dealing with the government of Alberta to think about a water exchange,” said Brabeck-Letmathe, describing the province as ideal for such a scheme because water there is scarce and competition for the resource between farmers and oil sands operators is fierce.

This was news to the government of Alberta, which swiftly moved to allay fears about the commodification of Alberta’s water, and its potential export. “Alberta’s water is not for sale and will not be,” Environment Minister Rob Renner told the legislature.

Yet Renner did not deny outright that the province had met with Nestlé, or others, to discuss the notion of setting up a water market in which licences to access the Crown-owned resource could be traded for money. (The province left it to Nestlé to clarify the issue: “Nestlé SA representatives have not met the government of Alberta to discuss an exchange-based water trade,” a press release said.) In fact, Renner signalled the province might indeed have an appetite for setting up such a system: “I think there will come a day, at some point in time, when we need to value water. Whether that means in the form of a regulatory regime or whether it means in some form of a market remains to be seen.”

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Carney: This time it's different

By Jason Kirby - Saturday, March 26, 2011 at 12:13 PM - 38 Comments

In a recent magazine story and blog post, we highlighted the tremendous benefits Canada has enjoyed thanks to the commodity boom, but warned that if you think this will go on forever, you’re basically saying “this time it’s different.” That type of thinking has coincided with every bubble we’ve ever witnessed, and was invariably followed by a loud POP!!.

Well, Bank of Canada Governor Mark Carney disagrees.

In a speech in Calgary earlier today Carney said the rise of the middle class in India and China does mean this boom is different than all the others that have come before it. ”Even though history teaches that all booms are finite, this one could go on for some time,” he said. (Here’s the full text of his speech.)

If Carney is proven right, here again is a chart we put together that shows how unbelievably, astoundingly history-defying his prediction would be:

Yes, that’s 200 years of booms and busts. Whenever 10-year average rates of return climb above 10 per cent, you’re into the danger zone, and as of a few weeks ago, we’d hit 12 per cent, according to Hackett Financial Advisors.

But Carney says this is a Supercycle, so the old rules don’t apply. His analysis seems to stand in contrast to his colleague at the Bank, Deputy Governor John Murray. Last year Murray warned against expecting commodity prices to keep going up forever: “If history is any guide, continuous rapid upward movement in real prices – oil or otherwise – is unlikely, as is a large permanent increase in the real price level.”

So who’s right—Carney or Murray?

P.S. someone will undoubtedly complain again that the chart doesn’t state which currency commodities were priced in. The chart measures 10-year trailing rates of return, priced in US$ terms.

Econowatch: If a giant stumbles…

By Chris Sorensen - Monday, March 14, 2011 at 1:21 PM - 1 Comment

For the past decade, it has been difficult to pick-up a newspaper without reading a headline about China’s phenomenal economic growth and its impact on everything from oil prices to global food supplies. And thanks to our resource-based economy, Canada in particular has benefitted from the boom in commodity prices sparked by China’s seemingly insatiable appetite for oil and other raw materials. But what happens if China’s growth were to slow dramatically over the next few years?

That is the question that two senior TD economists tackled in a report out today. While they caution their outlook is for moderating of growth to 9 per cent to 9.5 per cent between now and 2013, Craig Alexander and Pascal Gauthier conducted what they called a “stress test” for the Canadian economy by looking at the impact of a relatively anemic growth rate (for China at least) of just 5 per cent to 7 per cent over the same time period—an unlikely, but still possible, outcome of current efforts by the Chinese government to reign in inflation and keep housing prices in check. The results aren’t pretty.

While there would be an immediate hit to Canadian exports, it turns out that is the least of our problems. The real damage would come from a slowing of the global economy as a fragile recovery is knocked off course. Commodity prices would plummet, taking Canada’s economy down with it. In their model, the price of oil alone would plunge between 30 per cent and 40 per cent. “A swift decline in commodity prices would dramatically impact Canada’s terms of trade and aggregate income, with these impacts being especially pronounced among resource-based regions of the country,” the authors write, adding that overall income in Canada could fall by $100 billion in just one year.

Of course, this is likely a worst case scenario. But it nevertheless highlights China’s huge influence on our economic fortunes. For better or worse.

Two charts you need to see about commodities and the housing market

By Jason Kirby - Thursday, March 10, 2011 at 4:33 PM - 29 Comments

Our latest issue should be hitting stands today or tomorrow with a story looking at the love-in that investors, both international and domestic, have for Canada at the moment. (Online-only readers will have to wait a week to read the piece at Macleans.ca. Better yet, go buy a copy of the mag.) You’ll have heard the “Buy Canada” thesis many times by now—our vast resources, supposedly prudent government finances, strong housing market and resilient job sector make us a stand-out in the global economy.

But there’s a weakness to that string of logic. All of those strengths we like to boast about are underpinned in one way or another by the phenomenal commodity bull market of the last decade, which has reshaped the Canadian economy. The thing to remember though is that commodities regularly go boom and bust. Always have. So is this time going to be any different? You be the judge. (click to enlarge.)

The above chart is from this week’s magazine story. It tracks the running 10 year annual returns in overall commodities. Through wars (both hot and cold), easy credit booms and even the U.S. industrial revolution, any time the commodity market has gone through a period like it just has, a nasty spill invariably followed. With the TSX down nearly 680 points or 4.7 per cent this week on softening commodity prices, there’s an argument to be made we’re cresting the peak once again.

Investors aren’t the only ones who should be hoping the commodity bull market keeps on a’runnin’. The real estate sector has benefited in a huge way from strengthening resource prices, thanks to low unemployment and higher incomes, not to mention the  overall sense of invulnerability that’s come to pervade the Canadian mindset. But to truly appreciate the stunning heights Canadian house prices have reached, history is helpful once again. For our story we spoke with Robert Shiller, the Yale professor famous for developing the Case-Shiller House Price Index in the U.S. which tracks prices going back to 1890. In the absence of solid historical Canadian data, Shiller suggested “an exercise” of fusing his index with the Canadian Teranet-National Bank House Price Index, on the assumption that house prices in the two countries behaved relatively similar prior to 1990. Here’s the result: (click to enlarge)

By the looks of that, we’re well into uncharted territory. As Shiller told me, “This is just to give an impression how unusual things are in Canada now. Canada is going through a major historic boom, at least in comparison with booms in the US before 1990.” For what it’s worth, you can see Shiller’s full U.S. chart, and how house prices fell back to earth after the bubble burst, here.

I should mention that before posting the Shiller chart, I ran it past Simon Côté at National Bank of Canada who devised the Teranet index. He cautioned that the price gains of the past decade should be taken in the context of Canada’s nominal GDP gains over the past half century. Here’s what he had to say:

“I think you may find that, yes house prices have increased a lot in the past 10-15 years, but the price increases since the 60s or 70s may be in line with the change in GDP, in other words houses prices might not have increased more than the overall wealth of Canadians.”

Decide for yourself how much to read into the above charts. I’d just say that we’d all be wise to remember one thing: both resources and real estate are commodities, and rule #1 in commodities is what goes up, eventually comes down.