Hedge fund manager and noted short seller Jim Chanos targeted Caterpillar Inc. (NYSE:CAT) on Wednesday, in a presentation given at CNBC’s Delivering Alpha conference.
Caterpillar is dependent on China
Over the last few years, Caterpillar Inc. (NYSE:CAT) has been a tremendous performer. Since the March 2009 lows, Caterpillar Inc. (NYSE:CAT) is up more than 260% (in addition to a steady stream of dividend payments).
Most of that gain has been due to the Chinese economy.
Since the financial crisis, China’s economy has been consuming raw materials at a rapid rate. In November 2008, the Chinese government announced a massive ($600 billion) stimulus program. The result has been unprecedented infrastructure spending.
In 2010, China surpassed the US in terms of energy consumption and is on track to surpass the US as the world’s largest importer of oil by 2014. In addition to energy, China has been a big consumer of iron ore and copper. China surpassed the US in copper consumption back in 2002, and the gap between the two countries had been widening ever since. Over the last decade, China’s consumption of copper has increased by over 200%.
Caterpillar, as a maker of heavy machinery, has benefited from the commodity boom. As Chanos noted in his presentation on Caterpillar, 30% of the company’s revenue, and 50% of its profit, is tied to global mining capital expenditures.
China’s property bubble
But that commodity boom could be coming to an end. A growing number of economists and money managers have warned of a bubble in China’s real estate market, and if (or when) it bursts, it will devastate commodity prices and the companies dependent upon them.
Perhaps there is no better way to illustrate China’s property problem than to observe its “ghost cities” — enormous, seemingly abandoned metropolises.
Anyone interested in the space should watch 60 Minutes’ report on the phenomenon. The video footage of empty highways and shopping malls is reminiscent of a Hollywood apocalypse movie.
Famed economist Nouriel Roubini has said China’s economy is the biggest risk facing the global economy in the second half of 2013. He has been warning since 2011 that China was suffer from an “economic hard landing” as over half of its GDP has been going towards fixed investment — an unsustainable amount.
Other stocks that could crater
Of course, if China’s real estate market collapses, and it brings commodity prices down with it, it won’t just be Caterpillar that suffers.
In particular, Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) would be exposed to downside even more so than Caterpillar. As a miner, the company’s business is dependent on the market for copper, gold, and other minerals. As management admitted on the company’s last conference call, the Chinese economy “remains an important demand driver.”
Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) did recently acquire Plains Exploration, giving it a portfolio of US-based natural gas assets in addition to its mining operations, but even natural gas prices should not be expected to hold up in the event of a Chinese construction collapse.
Then there’s Australia. Stanley Druckenmiller, hedge fund manager George Soros’ old partner, recommend investors short the Australian dollar back in May. He reasoned that Australia’s economy was heavily dependent on the commodity market, and sagging demand would wreck havoc on Australia’s currency.
As a percentage of GDP, the mining industry accounts for nearly one-fifth of Australia’s economy.
iShares MSCI Australia Index Fund (ETF) (NYSEMKT:EWA) is a way for US-based investors to play the Australian economy. It holds 70 large- and mid-cap Australian stocks, including commodity giant BHP Billiton Limited (ADR) (NYSE:BHP), which makes up over 10% of the ETF’s holdings.
If China’s construction sector collapses, Australia’s economy — and by extension, EWA — should not be expected to perform well.
Investing in Caterpillar
Investing in Caterpillar is an indirect way to invest in China’s property boom. Should that boom go bust, Caterpillar shareholders could suffer as the maker of mining equipment finds the market for its products to be far weaker than it otherwise anticipated.
In addition, Freeport-McMoRan and the broader Australian economy could likewise suffer. At any rate, if investors are leery of China, it doesn’t make sense to be bullish on Caterpillar.
The article Why You Should Sell Caterpillar originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
Joe Kurtz has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Salvatore “Sam” is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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