Trading a Slowing Chinese Economy

Chinese growth has continuously slowed as the effects of the massive fiscal stimulus undertaken in 2009 have waned. Inflation has slowed and growth is decelerating, so much so that some economists are predicting sub-8% growth in 2012. Premier Wen Jiabao has seemigly admitted defeat in the aftermath of the massive 2008-2009 stimulus, and has now asked developed nations' leaders to do more.

As the G20 meeting aproaches, Premier Jiabao is determined to not have local governments take on bad debt as they did previously. China's $586 billion fiscal stimulus and over $2 trillion credit enhancement have led to bad investments at the state and local level. Fitch ratings says that the stimuli fueled a property bubble, stoked inflation, and led to the banks amassing lots of bad debt.

Chinese banks may now be deleveraging, causing a slowdown in both the property market and the overall economy. Leading growth indicators, such as China's PMI, are hinting that Chinese growth may continue to slow. Current PMI readings are concurrent with about 8.1-8.3% GDP growth year-over-year, however, a continued slowdown in manufacturing may lead to a further drop in GDP.

Traders should watch copper, Australian mining stocks, and the AUD/USD rate as key indications on the health of China. China is a major importer of copper, with most of it coming from Australian mines. Thus, Australian miners are a direct play on Chinese growth. China is trying to build new cities, new buildings, and new infrasturcture to power its still dark rural areas. To do so, they would need copper wires, and so copper is in large demand. Thus, copper prices are directly related to Chinese growth.

The AUD/USD rate, since Australian miners are tied to China, will thus be sensitive to China's economy. The AUD/USD is a risk pair, and risk sentiment drives this pair in most situations. Therefore, this currency pair is a great way to play Chinese growth. Other more sophisticated investors may consider the carry trade between the Aussie dollar and the Japanese yen as a good trade. Borrow yen, use it to buy Australian dollars via the FX market, and invest those dollars in an Australian bank account. The difference between the interest rates in Australia and those in Japan (interest revenue less interest expense) is the profit, known as the carried interest. However, do note that carry trades are highly risky and expose investors to margin requirements and leverage.