Chinese miners poised to win with US rate rise, while developers may see pressure if yuan loses ground
Among possible winners and losers following an anticipated US rate rise, analysts say mainland Chinese property stocks could see selling pressure if the yuan depreciates further, while Chinese gold and other metal miners may rebound after the recent commodity rout if the Federal Reserve takes a more cautious approach to the pace of futures rate increases.
The Federal Reserve is widely expected to increase its short-term interest rates for first time in almost a decade later on Wednesday. The lift-off is likely to generate volatility in money markets and create a ripple effect in global stock markets.
According to Jefferies Group, Hong Kong and mainland Chinese property stocks could see a “road split” after the rate increase, with Hong Kong developers drawing more investor interest.
“A major reason to adjust up the portfolio weighting (of Hong Kong property stocks) will be related to HK’s short-term rate outlook, as we argued HK is not going to follow the Fed to raise rates,” said Venant Chiang, equity analyst for Jefferies, in a recent research report.
Historically, the Hong Kong dollar base rate has followed the US rate to avoid massive capital outflow in rate increase cycles, especially since the local currency is pegged to the greenback.
However, Chiang said current conditions may allow Hong Kong to delay the rate increase, as the city has sufficient domestic liquidity to tackle capital outflows and the improved HKD loan-to-deposit ratio offers “higher cushion and flexibility” for local banks if the US raises interest rates.
If Hong Kong delays its rate increase, local developers could “utilize the extended window” to sell more properties, which will improve their earnings and balance-sheets, he said.
In addition, an increase in US interest rates may add to the depreciation pressure on the Chinese yuan. While a weakened yuan could worsen the profits of mainland property firms, more conversion from yuan into HKD deposits will “strengthen bank liquidity in HKD”. Besides, it is at the discretion of banks to decide rate changes that depend on loan demand and deposits.
“We believe this is a major top-down catalyst to attract buy flows into HK property stocks that have been oversold,” Chiang said.
The investment bank favoured benchmark index constituents, such as Sun Hung Kai Properties and Cheung Kong Properties.
On the other side, Jefferies said mainland Chinese property stocks could see selling pressure after a Fed rate increase, due to escalated risks related to RMB volatility and aggressive bond raising.
Since the second half of this year, the onshore Chinese yuan has already fallen approximately 4 per cent and the offshore rate has dropped 5 per cent.
Further depreciation of RMB could worsen developers’ income statements and balance sheets, Chiang said.
“Owing to high leverage and high proportion of debt denominated in USD/HKD, Chinese developers will recognise potential profit reduction due to foreign exchange loss in the income statement,” he said.
It may also push up the gearing ratio for developers, which is a measure of a company’s financial risk calculated by dividing its net liabilities by stockholders’ equity.
According to Jefferies’ estimation, a 5 per cent RMB devaluation will jeopardise major Chinese developers’ net profit by 21 per cent and net asset value by 6.5 per cent.
“Financial visibility could worsen alongside the dynamic currency market,” Chiang added.
Meantime, as China has relaxed in the domestic bond market, companies may aggressively issue new property bonds at home for offshore debt payment.
However, under the current scheme, developers’ intention to move money outside China may only put more devaluation pressure on the yuan, Chiang said.
Given that developers currently have a combined US$ 30 billion worth of offshore bond which will expire during 2016 to 2018, “to settle this scale of debt obligation may hurt a company’s financial position as a result of RMB volatility”, he added.
Among various players in the sector, Jefferies said smaller-sized property firms could be more exposed to industry risks compared with quality players.
Other Chinese equities that are sensitive to the Fed’s tightening include gold and other metal miners, as the prospect of a Fed rate increase has hurt metal prices since earlier this year.
Some analysts project a short rebound in prices for gold, copper, and other metals if the Fed takes a more dovish stance to future rate increases as expected, thus possibly spurring a rebound in the sector’s stocks.
“Historically, metal prices usually fall ahead of the first rise in every rate increase cycle, reflecting market expectations, but after the rate decision is made, in line with expectations, metal prices will see a rebound for a short period,” Chen Yan and Dong Yubo, stock analysts for China International Capital Corp. (CICC), said in a recent note.
Metal prices have been suffering from a prolonged weakness since 2011 due in part to worries over China’s economic slowdown and a glut in many metals in the world market.
Since earlier this year, expectations of a US interest rate increase also added to the downward pressure on metal prices, as a rate rise would strengthen the US currency, making the dollar-denominated metals more expensive for investors.
Gold prices have fallen 11 per cent since the start of June, while copper prices have tumbled 24 per cent.
Historical data from 1990s and the 2004-to-2006 period showed gold prices usually staged a mild rebound for about one month shortly after the first rise in each rate increase cycle, CICC analysts said.
Copper prices also recovered for about a week after the first rate increase in 1988, 1999 and 2004, they added.
Analysts expected gold, copper, aluminium prices to have a “short rebound” after the anticipated December rate rise, and suggest buying opportunities for Chinese metal mining stocks, including Shanghai-listed Shandong Gold Mining and Yunan Aluminium and Hong Kong-listed Jiangxi Copper and Zhaojin Mining.
However, they also warned against volatility in the sector if the Fed appears hawkish on the path of rate increases and the US dollar strengthens more than expected.