The IMF has upgraded its 2010 and 2011 global GDP forecasts to 4.6% and 4.3% respectively. Some claim we’re returning to a ‘Goldilocks’ economy – where growth is neither too hot nor too cold. It’s a nice thought – but complete nonsense, because it doesn’t take account of China. With over a third of its output generated from exports, there’s no chance China can ‘de-couple’ from the rest of the world and act as the fairy godmother. With Europe, its largest trading partner, retrenching, I could see 2011 Chinese GDP growth being closer to 5% rather than 9.6% as the IMF expects.
After a prolonged period of lax lending and gorging on infrastructure, there are masses of new highways, factories and even whole cities lying idle. The Chinese Academy of Social Sciences reckons 64 million empty properties sit idle across the country – more than twice the UK’s housing stock. With such an overhang, future construction will undoubtedly slow. Worse still, Standard Chartered reports that housing sales are down 60% in 14 major cities, as Beijing has clamped down on property speculation.
The upshot is that the commodities complex sits under a sword of Damocles. Rio Tinto CEO Tom Albanese nearly said as much recently, when he acknowledged “some weakening in sentiment” due to a “slight slowdown in Chinese growth”. This is a red flag. Rio is the world’s second-biggest iron ore exporter, and a major player in copper, coal, aluminium, mineral sands, and to a lesser extent diamonds and gold. China buys more than half of Rio’s iron ore, which in turn accounts for around 60% of the group’s value. And as vehicle scrappage schemes wind down in Europe, and housing support measures dry up in the US, demand for base metals could collapse.
Rio Tinto (LSE: RIO), rated BUY by Deutsche Bank
The urbanisation and industrialisation of Asia will be a winner long-term. But in the next couple of years, China will focus much more on building for its needs, rather than for the sake of it. This wouldn’t be too bad as long as Rio’s share price had factored in a hiccup in demand. But that’s not the case. I would rate the stock on a through-cycle multiple of six times Ebitda. After adjusting for $14.3bn debt, that gives a value of £26 a share. Interims are due out on 5 August.
Recommendation: SELL at £32.47