China: All is not what it seems

21st June 2012

Well, here is a story involving a business we do not own – and indeed both a theme and a country we are avoiding – that vividly illustrates why. For good measure, it also raises an awkward question or two about the global economy.

China's economy, according to its National Bureau of Statistics, grew 8.1% over the first three months of 2012 while quarterly fixed-asset investment – essentially construction and infrastructure and one of the country's principal economic drivers – surged 20.9%. Yet, according to an associated trade group, the China Construction Machinery Association (CCMA), sales in China that quarter of bulldozers, diggers, loaders and so forth plummeted.

At least one of these pieces of information must be wrong or there would appear to be some strange things going on in the Chinese economy. We would not presume to suggest which piece it may be, although the bearish headlines concerning Chinese property construction have been there for all to see.

So let's examine the case of one particular business operating in the Chinese construction sector – the Hong Kong-listed Zoomlion Heavy Industry Science and Technology Co. With sales of some $7bn (£4.5bn) of construction equipment every year, it is a big company and, in that tough first quarter for heavy construction machinery, it actually saw its sales grow by 8%.

Not bad going with markets so tough, however not everything is as it may first appear in the Chinese bulldozer market. For one thing, analysis by stockbroker Jefferies shows that a lot of machinery Zoomlion sold in the first quarter went to customers who do not need it – for example, Jiangsu Province has been one of the company's biggest areas of sales growth and yet it currently uses only one in three pieces of heavy machinery it owns.

That should serve as one warning flag. A second stems from the fact that when a Zoomlion client buys something, they are not actually required to pay anything upfront. Some people might commend Zoomlion for the very generous financing terms it is offering its customers but the practice does raise the delicate issue of when a sale is not a sale.

This also leads on to a third red flag, in that many such customers take delivery of their bulldozer or whatever and immediately use it as collateral against a loan from a bank. There is a real liquidity crunch going on at the smaller end of the market in China with small and even mid-sized companies finding it tough to borrow money from the country's regional banks.

Using heavy machinery for which they have not even paid a deposit as collateral is a handy way for such companies to find financing. However, at the very least, such a practice highlights not only an issue with borrowing in certain areas of the Chinese economy but also that companies are booking sales and revenues on the basis of false demand – their customers are actually after financing rather than diggers.

In a price mechanism such as China's, things can become confused. Any question marks over its ability to finance businesses or the validity of sales booked by its companies, or even ones resulting from any differential between official statistics and what appears to be going on at the ground, can hardly be good news for the country or, very probably, for other parts of the world.

To return to our original point, the case of Zoomlion is a fairly broad-brush illustration of why you need to be very careful when assessing a potential investment. For one thing, following a company's cashflow is usually more important than trends in a company's revenues – an approach that would have highlighted very quickly a few of the issues surrounding Zoomlion's sales growth.

Continue reading…


More on Mindful Money:

The Empire Strikes Back II – Rolls Royce Drives to Success

The great fall of China?

China: Behind the headlines

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23 thoughts on “China: All is not what it seems”

  1. Drf says:

    Hi Shaun,

    “What I mean by this is a country which has an economy which looks as if
    it is sustainable for the long-term and Switzerland would get quite a
    few ticks on such a list.” Well of course it will now get less ticks on the list because having agreed to end banking secrecy there is going to be a large outflow of wealth from their banks! Since a great part of the Swiss economy has always been based on international banking and banking secrecy that is going to weaken it considerably; I suspect it is because they knew they intended to comply with the EU and USA demands that was part of the reason for pegging the SF against the Euro?

    You mention that there is no return on Gold (as with all precious metals and commodities per se); but that is surely not the issue. Investors have been and are moving into precious metals not to seek any return; in most traditional “investments” at present it is not possible to achieve a real net return because of the erosion due to REAL inflation. It is all about real purchasing power and net yield; precious metals allow a hedge against the inevitable future latent inflation, and are likely at least to retain your purchasing power, although there is unlikely to be yield. However it is quite possible that with some commodities and some precious metals there actually may be an effective yield once hyperinflation sets in, because real consumables which humans need will escalate in price, but Gold will buy more of them. Gold and silver will become again the de facto real money. It is worth reading Adam Ferguson’s short book: “When Money Dies” again.

    1. Anonymous says:

      Hi Drf
      Actually there was quite a change in the recent pattern of the Swiss Franc today as it rallied strongly to Euro 1.228. With the Spanish Prime Minister having slush fund problems and Silvio Berlusconi apparently back on the scene it will be interesting to see what happens next.
      I am neither a gold bug nor a denier but if pressed the more I read about the antibacterial qualities of silver those who favoured it in the past may have been right all along!

      1. tam says:

        can you explain clearly about safe haven and hedge (can you give me an example)?

  2. taurus says:

    Hello Shaun,

    I think it’s a case of ‘you pay your money you make your choice.” There are a good number of commentators predicting hyperinflation as the end game and for gold to rise to unparelled levels. Some boldly predict this will occur within twelve months while other litter their predictions with caveats. There are many sites whose devotees believe the end of the fiat money system is nigh(but cannot actually say when) and with the reset the introduction of the gold standard(but do not actually say how) All I know is whatever happens I will have backed the wrong horse.

  3. ernie says:

    Interesting post Shaun. I have been wrestling with this since the period in early 2008 when I began to see how it was going to unravel. I have never actually come to an answer though! Of course, it critically depends on two things. Firstly, your age, which will affect the course of action that seems right to you. A person of or about to be at pensionable age will be much more risk-averse anyway, whereas a younger person may be able to take a longer view.
    Secondly, it depends on your overall assessment of the situation – the famous deflation/inflation debate. This is very difficult to resolve as the ridiculous printing of money vies with the strong likelihood of grossly-inflated asset prices collapsing at some point as the leverage comes out (again as per 2008). I don’t pretend to know the answer but I do feel that not enough people look at the possibility that we have lived through inflationary times through the provision of massive amounts of credit to enable leveraged activities. Maybe the other side of this coin is significant deflation as the laws of arithmetic cannot be denied – that is constantly increasing debt/leverage is impossible. I put it out there just as a thought, since I have to agree no-one could have foreseen the absurd lengths to which governments have gone to avoid prices reaching clearance levels and debts being reduced sufficiently to allow growth to resume.

    1. Anonymous says:

      Hi Ernie
      I have suggested often in the past that we can see disinflation in some things and inflation in others at the same time. I have not come back to it recently so I will put it on my list!
      It sounds illogical but for example we have had commodity based inflation whilst the price of labour has seen falls in real terms. An uncomfortable situation to say the least.

    2. JW says:


      Just plot CPI/RPI indices ( not annual variations) in US/Europe/UK over the last 30 years. The western world is completely and utterly in an inflationary situation. Deflation is a figment of CBs imaginations.

  4. Justathought says:

    Hi Shaun,

    Based on those wonderful and uncertain times we are
    presently living in, where economic theory has been thrown out of window, where governments are no longer governing but are simply curators and where many moral standards are failing. To assume the worst of the situation and to return on some fundamentals in order to not only protect ourselves but to sustain a decent living standard would be of a prime concern.

    It appears to me that we might be living a replicate of the 2006/2007
    UK’s years … While in the streets an uneasy “feel” was blatantly perceived regardless of the pretence entertained by the media, news manipulators and governments’/official’s propaganda.

    Gratefully we have some accurate and trustable bloggers such
    as yourself to shine some lights within this maze of data’s and misinformation.
    Unfortunately, nobody would know with certainty what would be in three years’ time, nonetheless within six month.

    1. Anonymous says:

      Thank you.

      With Prime Minister Rajoy in Spain in trouble over slush fund payments and Silvio Berlusconi coming back lazarus like in Italy it has not been a good few days for officialdom. And that is before we get to Chris “I am innocent of all charges” Huhne…

  5. Anonymous says:

    Are the CB’s not still buying gold hence self supporting prices?

    Also Cyprus appears to be exposed to extra austerity with the EU wanting to punish Russian inflows?

    1. Noo 2 Economics says:

      Gold’s been in a downward trend since last September – abiout 8% down, which, imo coincided with an increasing positive perception of the future (although I don’t share it) of investors. If CB’s are buying gold they aren’t doing a very good job at supporting it’s price.

    2. Anonymous says:

      Hi Chris
      Yes they have been buying and the World Gold Council estimated that it amouted to 500 tonnes last year. Noo 2 is right to point out that the price has fallen but if they are buying for the long-term they may see it as a dip to buy into.
      Mind you care is needed as central banks (not only Gordon Brown) sold at the lows and are buying at near the highs or #toppedandtailed

  6. Noo 2 Economics says:

    Hi Shaun,

    Glad to see you respond to readers requests as I’ve been waiting for this since someone requested it a while ago.

    Are we not in a position of oil steadily increasing as the Fed gets into it’s stride with QE and speculators buying oil in anticipation of the BOJ printing activities?

    Maybe oil is the current “safe haven” with all the bonhomie I see on the bourses until they realise the markets are massively out of sync with the real economies and then will come the correction in markets and oil (down) and gold (up) as imo investors continue to see gold as possessing intrinsic value.

    I would suggest another potential short term “safe haven” of China as it’s economy has grown (albeit at a slower pace) last year whilst it’s stock market collapsed only starting to recover last November/December.

    So maybe it’s as I guess you are suggesting, the “safe haven” nowadays keeps moving around and to find it you need market timing. Who can time markets accurately?

    1. forbin says:

      Hello Noo 2

      a little on oil – it doubled in price between 2002 and 2005 and then doubled again – forget the supa spike that prob was computer trading plus a lot of hot money ….

      currently oil is at around 110-117 mark

      current chines growth in oil import suggests that by 2027 they will be taking all of the current available exported oil – now I don’t believe that will happen for various reasons.

      factor in the high decline rates of all the “old resource” tight oil thats become a reserve because of the high oil price

      and we get the picture that baring a major economic collapse , that oil is only going to go up.


      1. Noo 2 Economics says:

        Thanks Forbin, So are you saying that, accepting volatility along the way, maybe oil is a long term safe haven? And what about popcorn?

  7. Rods says:

    Hi Shaun,

    An excellent article again.

    Once a safe haven has been identified and written about, due to investors herd instincts it is probably much less of a safe haven, with early adopters making money and late arrivals not! Six months a go investors were talking about shares looking cheap on a price / yield basis and if you were an early investor this was probably true, but now there is considerable scope for a share correction and losses on a run of bad news.

    I look at derivatives as a bit like insurance using them to quantify risk, by turning an unknown risk into a known cost. It makes perfect sense for say a airline to hedge their fuel costs and accept the cost of the derivatives when they are booking flights at fixed prices up to 12 months in advance. Although I never costed this, could it make sense to use of dividends from shares to protect your capital when you have purchased shares in a rising but volatile market? A bit like we have had over the last 5 years and we could easily have a correction again with bad news later in the year with a Sterling crisis brewing and I’m sure many more issues in the Eurozone. It looks like the next tipping point maybe political rather than economic in Italy and Spain.

    It is my understanding that holders of shares like Insurance companies use derivatives to make extra money (hopefully!) by using their shares in derivative deals.

    If I had money to spare at the moment I really don’t know where I would invest it. Shares are still probably the best long term bet against inflation but that is going to depend upon the companies exposure in different countries and how those economies perform? I think I would be steering clear of the UK and Europe.

    1. Anonymous says:

      Hi Rods
      Derivatives were my living for quite a few years! But whilst for some they can be a safe haven trade as for example selling call options against a shareholding someone has to take the other side. Also I suspect that say like zeroes in the UK some things which are badged as safe turn out to have been very risky…

  8. forbin says:

    Hello Shaun,

    Whats a safe haven – land and property – seems to have lasted millenia

    needs some type of stable government – oh you mean short term!!!

    nimble of foot I think – still land and property though ! 😉

    Selling some London flats to the French emigree might be worth while

    indeed Shaun I understand that the companies are holding onto wads of cash waiting for something to invest in – why is that ? how long can they hold on ?

    perhaps we need our Governments to have more balls and tax those holding on!

    yeah right , no hope there …..


    1. Anonymous says:

      Hi Forbin,

      Property isn’t necessarily safe – just look at the houses the Spanish are bulldozing due to lack of planning permission. Lots of money has been lost in Spanish apartments too. I think this property market has further to fall and is being held artificially high by forbearance on foreclosures.

    2. DaveS says:

      Actually Shaun – I constantly read that UK companies are awash with cash – we just need business confidence to improve and they will invest,.

      I had a few questions around this topic – maybe more of a subject for a future blog….

      1. Also read that SME’s are being starved of lending so I assume that means only big UK companies are awash with cash.

      2. Was wondering which big UK companies exactly ? If I look down the FTSE its hard to see what sectors would be awash with cash – maybe big miners but they are essentially foreign companies that are domiciled here – they are hardly going to start digging holes in the UK. The big supermarkets perhaps but then they are “investing” – we are awash with express stores these days.

      3. Before the crash I thought a lot of UK companies where highly leveraged in the boom e.g. private equity deals, property developers – surely they are having to de-leverage.

      So it it more a case that they are paying down debt rather than building up cash piles ?

      1. Anonymous says:

        Hi DaveS

        I note the request and can already help on question or point one.

        Lending to UK businesses by UK banks fell by £2.5 billion in November and by £2.1 billion in December which is not exactly auspicious for Funding for Lending. And yes SMEs seem to be getting the worst of this as net lending to them has been negative since the second quarter of 2011.

        1. james says:

          Hi Shaun,

          I am convinced that banks are not lending :the rates of interest on savings are dropping all round which makes me think that they do not need to attract deposits because they won’t lend

  9. Justathought says:

    Hi Shaun and others participants, out of topic however some relevance embedded within this vid might appears…

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