Beware of the Other China Bubbles

Published: Thursday, 9 Jun 2011 | 11:31 AM ET

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Kick Images | Photodisc | Getty Images Flag of the People's Republic of China

The deflation of the great Chinese property bubble will not directly hurt most US investors, but there are other bubbles linked to Chinese property that could.

The report in Thursday's Wall Street Journalmakes it clear that the Chinese property bubble has popped. But the story doesn't end there.

China accounts for almost half of the global demand for steel, and at least half of that goes into construction. If the deflation of the Chinese property bubble leads to a slowdown in property development—as it almost surely will—global demand for steel could slow dramatically. That means that companies making big investments in steel production or iron ore mining could find that they've over-invested.

Another story in today's Wall Street Journal paints a picture of what over-investment in iron ore mining looks like:

The largest iron-ore mine in Australia will take a leap in efficiency starting next April: 10 automated trucks, one remote driver.

With demand from China and other steel-hungry industrializing economies rising, the massive trucks—programmed to haul ore and waste around the pit using the global positioning system—are part of a push by Rio Tinto [RIO  66.96    -1.99  (-2.89%)   ] PLC to to adopt automated technology to cut costs and ramp up production even in the face of a labor shortage.

This kind of thing doesn't come cheap. Rio Tinto plans to invest almost $15 billion to expand annual iron-ore output in Australia.

There are similarly huge expansions going on in India and Brazil. Rio Tino, BHP Billiton [BHP  90.09    -2.08  (-2.26%)   ], and Vale [VALE  30.88    -0.52  (-1.66%)   ]—the three biggest suppliers of iron ore—plan to spend $US45 billion on mines over the next few years. If the Chinese property bubble deflates, the "iron ore bubble" will deflate too.

An "iron ore bubble"? That's not a phrase I invented. I first heard it from the chairman of China's second largest steel mill.

Bloomberg reports:

The iron ore market has risen to “bubble” levels that will burst as new mines create oversupply of the steelmaking raw material, according to Baosteel Group Corp., China's second-biggest mill.

“There is a bubble in this market, many are gambling,” making acquisitions and investment expensive, Chairman Xu Lejiang said in an interview in Shanghai, without saying when prices would drop.

“Everyone who has money is rushing in to invest in iron ore.”

The next domino after iron ore would be shipping. Forty percent of the dry-bulk shipping industry revolves round moving ore to China. That could mean more trouble for Greece, which is one of the world's largest shipping centers. Norway, Hong Kong, Singapore, and South Korea could all see their economies hurt by a fall in demand for shipping to China.

Chinese growth has been one of the great investment themes of the past decade or so. But now that China's property bubble is deflating, exposure to it might have serious costs.