Gary Shilling on China, Commodities and the AUD

Gary Shilling is the president of A. Gary Shilling & Co., Inc. and author of the best selling book The Age of Deleveraging.

Earlier this month, Shilling gave an interview on Tech Ticker, where he outlined why he believes China’s economy is headed for a hard landing and what to do in order to profit from the slowdown.

Hard landing within 18 months:

Shilling believes that China will experience a ‘hard landing’, defined as 6% real GDP growth or below, within 18 months.

According to Shilling (paraphrased):

China stimulated their economy enormously in 2009. Their stimulus program was 12% of GDP versus the US’, which was half of that at 6% of GDP. They got instant results. But they also got a property bubble and they got inflation. And now they are trying to curb both sides. They are tightening and they are now trying to cool that off. I think they might have a hard landing coming out of that…

Shilling also believes that the world is experiencing a commodity bubble, as evident by the amount of money that is flowing into commodities by not only traditional commodity players – speculators and hedgers – but also institutions, and individuals via exchange-traded funds and physical holding of commodities.

According to Shilling, China’s hard landing will prick the commodity bubble. Industrial commodities will be hit first (e.g. copper, iron ore, etc), followed by agricultural commodities. With all the hot, leveraged money congregating in commodities, speculators there will seek to unwind their positions quickly in order to preserve capital.

How to profit from the downside:

Shilling recommends shorting the currencies of the major commodity producing countries, namely Australia, New Zealand and maybe even Canada.

Shilling singles-out Australia in particular, noting that “Australia is really a Chinese colony. They’re digging-up that island continent and shipping off the iron ore and copper to China”.

I recommend that readers watch the video for themselves. It certainly challenges the bullish views expressed by Australia’s mainstream economists and commentators.

Cheers Leith

[email protected]

Unconventional Economist

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

Latest posts by Unconventional Economist (see all)


    • Chanos reckons he’s done well so far on his China-bear positions.

      I call balls!!

      How can anyone who has shorted the big Australian resource companies have done well? Especially when their rise in value has been spectacular from an $US persepective.

      I’d be more impressed if he said “we’ve done crap so far, but hoping that our predictions will come true”.

  1. Leith,

    You know Jim Chanos talks about 60 – 70% of Chinas GDP is construction. Do you know of somewhere to verify this somehow.


  2. Endrortsonhousing

    I think some of the American commentators on China see things through an American prism.
    Americans can have a hard time accepting that they are about to be replaced as the world’s leading economy.
    Also because America has been in recession for so long, they assume that the rules that apply to the mature American economy also apply to China – but China is what America was 120 years ago.
    That is not to say that there might not be short term busts in China, as there was in the US, but looking at the history of the late 19th and early 20th century busts in the US, they were more a product of shifts in sentiment than ‘overheating’.

    • Fair enough. However, you also have punters such as Marc Faber and CLSA pundits who share similar perspectives. They are much closer to China itself and they most definitely don’t see the world through a U.S.-centric prism. Furthermore, after watching the video, Schilling doesn’t make any long term prognosis for China.

      Personally, I am skeptical of the possibility of such a certain event occurring (simply because I don’t know how anyone can know with any strong degree of certainty about the time frame). However, in the case of his recommended actions of shorting AUD & NZD, I think it could be a very profitable bet).

  3. I’m amused by the idea that slowing to “only” 6% growth can be seen as a hard landing. Also, it is hard to see commodity demand being really hammered if China continues to grow at 5-6%. That growth has to come from somewhere.

    • Alex. I would put far more weight on the opinions of guys like Chanos, Shilling, Vitaliy Katsenelson, and the guys from GMO than the academic perma-bulls at the RBA and Treasury. After all, these guys have had long and successful careers and have made loads of money on the conviction of their calls. Ignore them at your peril.

      • Agreed. And it’s important to note that the likes of Chanos and GMO are bullish on China long-term, they just don’t see the current growth trend as sustainable.

    • Alex, its the relative speed of the GDP growth that is the key. At 6% growth, China is not able to maintain its urbanisation at the same pace that has been going on for the last decade…

      All the assumptions that RBA and Treasury have made is based on the misguided belief that China can consistently grow through its command and control economy

      So yes, the Chinese will still demand our minerals – but not anywhere near as much and so with demnand collapsing, so will prices

      Thanks Leith for pointing this interview out…it was a very simple bear case against China.


  4. Alex, a reduction in real GDP growth from ca. 9-10% to “only” 6% implies a 40-50% reduction in growth – therefore 40-50% less metals, ore, concrete and other commodities, as the Chinese switch to a consumption/service based economy, not a construction/infrastructure development based economy.

    This change in underlying change will have vast effects for those Chinese who have not benefited fully from a roaring economy.
    Large GDP growth rates are required for developing economies to lift from the pre-$1 a day marginal living standards to the more common $5-50 a day standards. This is completely different to the Western-style economies that only require 2-3% real GDP rates, mainly to facilitate debt servicing as most of their populous is already wealthy and is stabilising (or dropping) in size.

    Any significant slowdown will have ramifications in certain sectors of Chinese society (particularly Western China) that want what the rich coastal Chinese city-states have.

  5. It doesn’t necessarily matter when a Chinese downturn or change of the economy will happen. Fact is that Australia is letting an important opportunity to lay down a foundation for the future slip right through its fingers (except for the NBN of course). So when it happens, a couple of months down the road, or a couple of years… there will be nothing left to run our economy!

    I am absolutely astonished that there is no activity whatsoever in Canberra to put our current luck (‘cos that’s what it is, nothing more) to good use.

    No vision, no long term strategy, no plans, nothing.

  6. Please define GDP calculation in USA.
    Please define GDP calculation in China.
    Are both manipulated statistics or one of them?
    How reliable are they? Ditto inflation calculation rates.

    Are we comparing a basket of “mock” apples to a basket of”mock” oranges?

    The speculative gains mentioned by the speculators above have, in the main been in their home countries.

    So the arbitrage is between statistics supplied by the home grown liar versus the lies of the foreign statistics supplier.

    International speculation is a different ball game. Ask George Soros.

    What if China opts for a deflationary bust (rising currency) vs a USA inflationary bust (currency depreciation)?

    Sounds like a date with model failure. Zero sum game speculators.

    Speculating on speculators who are speculating on assumed (speculative)statistics has all the hallmarks of LEVERAGED RISK.
    Luck vs skill?

  7. Anyone else see a contradiction here? If China is becoming this economic superpower, primarily on the back of its move towards urbanisation, why did it need to stimulate at a level of 12% of GDP? The fundamentals clearly stink adn I can’t see why anyone would be convinced by data produced by a communist country still in the dark ages.

  8. I believe the costs of most non income producing assets, e.g. houses, boats, cars will decline probably within the period mentioned here (18 months)…I say probably because, there was a lot of people (me included) who thought it would have corrected many years ago.
    But the Govt of the day prolonged the inevitability of it by the first home owners $14k bribe.
    I live on a yacht (5 years) and monitor moored yacht prices, looking to upgrade sometime in the future. Prices have dropped a lot, and not much is selling, however, in my case I think I will just hold on to my cash and wait……
    I often wonder what is the critical mass required of Australians thinking like me is needed to cause deflation.. Will it be a y = x 2 parabola graph, that when the only a few cows are spooked (desperate sellers of above) it takes time to gain momentum but when momentum is under way… the herd stampedes and takes all before it.
    I guess I won’t need to ponder the above question much longer.

  9. What is the best method for an individual to short the AUD over a period of 6-18 months? Assume one AUD will be worth between .50 and .80 USD. Looking for a large return – like 10x investment or more.

    • Simple – buy a couple of 100K 0.80 to 0.85 AUDUSD Puts 12 to 18 months out.

      AUD goes below strike price v USD – you make a grand per cent/100k

      If it doesn’t reach your strike price – you will lose the lot!!

      Welcome to forex options – please watch your step on the dead bodies!

    • Gold is one.

      But if you need to ask on the internet for an investment idea and still expecting 10x return, you will more than likely join Sandman’s dead bodies………

  10. A number of people above have suggested that a reduction in China’s GDP growth from current 9-10% to 5-6% will mean drastic reductions in demand for commodities. I believe this is a false argument and is predicated on a misunderstanding of the current nature of the Chinese economy.

    China’s economy is currently hugely driven by the construction industry, which constitutes around half of GDP. When we think of the construction industry in the West, we think of new apartment buildings and office blocks. While it is true that there is a large number of these being built in China, I do not believe they constitute the majority of the construction work. China is building more power stations every year than exist in Australia. They are building roads, railways, schools, airports, hospitals at a furious rate. They are building factories, sewage treatment plants, water treatment plants, dams etc etc etc. They are going from a pre-industrial society to a post-industrial society in one giant leap.

    I do not think a slowing of growth can put much of a dent in commodity demand, simply because even if the economy did not grow at all, 50% of it would still be construction, which still requires large volumes of concrete and steel. This in turn requires lots of iron ore, coal, copper for wiring etc.

    So while demand may ease, and there may be a short term drop in commodity prices at least partly related to Chinese stockpiling, the demand cannot drop significantly until China is a 21st century post-industrial country. I personally can’t see that happening for at least 20 years, and possibly more like 40. That means commodity prices will remain high, although maybe not as high as they are right now.

  11. Alex – I think the key point here is the huge amounts of leverage in the system from investors betting on the whole China story.
    I reckon you’d get a disproportionate hit in many of the instruments that are being used to bet on this story: including commodity futures, the Aussie dollar, shares in commodity producers, etc.

    • Yes, it is true that a number of these will take a beating. But how much impact will it have on the lives of ordinary Australians? Perhaps they will have to put off buying a bigger TV or a new car for a bit longer. They will have to pay a bit more for petrol. On the other hand, a lower dollar will make our other exporters more competitive. Apart from that, life goes on.

  12. Three points:

    (1) High GDP growth doesn’t equate to high stock market returns (observed correlations are actually slightly negative – ‘it’s all in the price’). China can still grow at high single digits but deliver poor stock market returns (that includes anything that is China-beta-sensitive).

    (2) The composition of future Chinese GDP growth is crucial. Everything in the five year plan points to growing internal consumption (how else are all these vacant buildings going to be afforded and filled?). If 9% (hypothetically made up of 6% fixed investment, 3% consumption) becomes 6% (hypothetically made up of 2% fixed investment and 4% consumption) then commodities go BANG! Because:

    (3) Prices are set by the marginal buyer/seller. Developed market commmodities demand has been stable to marginally declining over the past decade. China IS the marginal buyer (compounded by the speculative financial interests which ultimately are dependent on China being the marginal buyer). As soon as that marginal demand dynamic shifts, the sector is hugely exposed.

    Just my beliefs, for what they are worth. Like many, I have thought this for a few years now and have been so far proved wrong by extraordinary monetary stimulus. It has to end in tears.

  13. There will come a time when China and Australia govts will have to quit stimulating the economies. All they are doing is putting a band aid on the wound. At some point the market has to go through a correction. Markets throughout history have boomed and busted. China and Australia are no different. The question is how hard of a landing is it going to be when the time comes.