Here We Go Again: Another Warning Sign from Rio Tinto

Dear Reader,

The US–China biffo is the gift that just keeps on giving. And Australia is slap-bang in the middle of the fight. For now, in a good way. But later, perhaps sooner rather than later, it will take a turn for the worse.

The South China Morning Post reports:

New US rules restricting exports to China to prevent sensitive technologies from being used by the Chinese military are the latest development in the deteriorating relationship between the two countries. And the worst is yet to come, legal experts say.

The new rules, which went into effect on June 29, expanded requirements for US exporters to obtain licenses for goods intended for military purposes, including for weapon development, military aircraft or surveillance operations.

After China imposed a national security law on Hong Kong a month ago — alarming US officials who now regard the city as merely another part of the mainland — Washington swiftly removed Hong Kong’s export licensing privileges to restrict its access to “sensitive US technology” and cut off Beijing’s access to hi-tech goods that can be used to bolster the PLA.

Meanwhile, here in Australia, we’re still in the ‘phony war’ phase. Thanks to China, the dollars continue to flow through the economy.

Market Expert Predicts ‘Double Bottom’ for ASX. Find out how to safeguard your wealth.

From the same publication:

Australian mining giants Rio Tinto and Fortescue Metals Group have joined BHP Group in reporting record shipments of iron ore, the bulk of it to China, as an infrastructure and property construction boom in the world’s second largest economy drives a rebound in steel production.

The companies have reported record earnings on the back of the iron ore shipments, even though exports of other minerals like aluminium and copper remain in the doldrums as the coronavirus pandemic saps global demand.

If China’s economic woes cause them to hit the stimulus accelerator and build more empty apartments and roads to nowhere, we should want more of it, right?

Well, this has been the China playbook ever since the GFC.

Apart from an attempted economic rebalancing from 2012–2015, it’s been a one-way gravy train for Australia, and especially Australia’s iron ore sector.

But the flip side to Australia’s iron ore wealth dividend is this:

China’s debt-to-GDP ratio has gone from a manageable 160% in 2008 to a dangerous 330% now.

As China’s economy slows, how is all that debt going to be serviced? When there is a default on debt, it represents the destruction of money. One person’s debt is another’s asset. Default on the debt and the asset becomes worthless, or at least worth a lot less than you thought it might be.

That is how ‘money’ (at least credit-based money) disappears.

China is desperate to avoid this fate. Which is why its state-directed fixed asset investment growth is surging again. Surely, they know it’s just going to make the debt-to-GDP ratios even worse? I mean, the authorities have said they want to expand bank credit (debt) by around 20% this year. The economy will be lucky to grow 3–4%.

You can do the math on that one…

Investors ploughing into iron ore stocks are oblivious to this right now

Look, they could be right. China may have another year or two of this insanity to look forward to. And iron ore companies just have to keep shipping their dirt.

But the charts sometimes give you clues. And when I was scrolling through a list of companies the other day, Rio Tinto’s chart made me pause. I tweeted it out (I’m @gcanavan2).

Check it out…

Port Phillip Publishing

Source: Optuma

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What does ‘distribution’ mean?

Distribution is a term coined to describe the process of what happens during the topping out of a share price. Those who have been in the trade from early on in the bull market ‘distribute’ the shares to the latecomers.

Distribution patterns are often volatile. This represents the fact that there is an arm wrestle between the bulls and the bears. As you can see, the share price peaked last July. It sold off sharply, before rallying back to that high in January.

It then sold off again. I wrote about that in early February in the Rum Rebellion:

Note how RIO’s share price rallied back to the peak from July last year and turned down. Meanwhile, the broader market broke out to new all-time highs, surging past the July 2019 high.

In other words, RIO is now underperforming the broader market. Is this a sign that the commodities bull market that got underway in early 2016 is now over?

What implication does that have for the Aussie economy and interest rates?

It’s too early to answer those questions. But it’s worth keeping an eye on this economic/commodity bellwether, along with BHP, for clues on China’s growth.

Bullish, optimistic and complacent investors might not notice these things, but the market will always give you clues and early warnings if you care to look.

It certainly gave a warning in January/February. We just didn’t know at the time that a pandemic was about to shred China’s economy.

If Rio can’t break out to new highs here, once again, it’s telling you something about China’s economy. And it’s not good. Keep an eye on it as the ‘good news’ continues to flow. It will tell you what’s going on way before the mainstream headlines do.

To access my comprehensive report on the China/Australia break up, and how to play it from an investment angle, click here.


Greg Canavan Signature

Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

Learn more about Greg Canavan's Investment Advisory Service.

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