Slowing Chinese growth has captured the media's attention. But good headlines don't necessarily make good investment advice—the country is still buying massive amounts of key natural resources. That's going to help commodity markets clear oversupply situations quicker than you may expect.
Slowing, not stopping
For mature nations like the United States, growth hovers in the low single digits over time. There are periods where growth is quick, balanced by stretches where the economy actually contracts. Demand for natural resources like oil, iron ore, coal, and copper tend to shift along with the economy.
China is different; it's still moving up the economic ladder. So while the U.S. economy can hit a soft patch and get smaller, China's growth is slowing—not coming to a halt. Case in point: China's growth in 2013 was the slowest in over a decade, but the 7.6% figure is still quite fast compared to other nations. Even though the Asian giant's growth will probably continue to slow, it will remain one of the world's fastest growing economies for years to come.
Getting what's needed
That's why China's imports of iron ore, coal, and oil were at record levels last year. Aside from oil prices, which remain relatively strong, you would think that no one was buying commodities if you looked at their prices. But the issue is less about demand than it is about supply. That's actually pretty good news since companies like Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) have been slowing down their expansion efforts.
But that doesn't mean the supply troubles are over. For example, in a recent quarterly conference call Joy Global (NYSE:JOY) Executive Vice President Edward Doheny noted that there were still troubles in the metallurgical coal space: "We know where we put in a lot of our longwall systems around the world. And so we know we have some high productivity, low-cost [met coal] production coming online in 2014."
Big mining projects take years to complete, so it's hard to get the timing right and even harder to pull the plug once they are started. For example, despite the current price weakness in the potash market, BHP is still working on its Canadian potash mine. It won't produce for several years, and by then, the supply/demand imbalance will, hopefully, have been worked through. For Joy, however, the industry wide pullback on capital spending is likely to leave results weak for at least another year.
A distinctive feature of coal and oil is that they are both consumables. And since China is still building lots of new cars and coal-fired power plants, look for thermal coal and oil to be increasingly in demand. That should be good news for coal companies like Peabody Energy (NYSE:BTU) and Chinese oil players CNOOC (NYSE:CEO), PetroChina (NYSE:PTR), and China Petroleum & Chemical (NYSE:SNP).
Met coal, which is consumed in the steel making process, however, is likely to see more volatility based on construction and manufacturing trends. That could keep results at Rio and BHP, which are both big producers of met coal and iron ore, on the volatile side. However, when it comes to China, demand isn't the big concern. So, when supply and demand equalize, this pair could see a quick uptick in their selling prices.
The long and short of it
Copper may be the lone standout right now. Unlike the commodities above, supply and demand are relatively well balanced. That puts big copper players like Freeport McMoRan Copper & Gold (NYSE:FCX) and Southern Copper (NYSE:SCCO) in a good position as we move through 2014. In fact Joy's Doheny thinks copper has the strongest fundamentals.
Interestingly, Freeport recently moved into the oil space, following the lead of BHP, so it appears to be positioning itself well overall as it diversifies its business. That could make Freeport one of the best performers in 2014. However, Rio and BHP are both worth a deep dive if you are looking for well-diversified miners with longer-term appeal. It would also be worth your effort to look at the oil names, since the U.S. gasoline experience suggests huge oil demand in China is just around the corner.
Speaking of automotive growth in China...