China: Equity, Bond, and Crude Oil Purchases

Published on October 6, 2016

*** China’s state-owned financial institutions have been reallocating equity and bond purchases away from the US and towards Europe since late June, selling over $65 billion worth of US stocks and treasuries and investing the proceeds in European, and especially UK, equities and bonds. That reallocation is expected to continue. ***

*** Three considerations are driving the Chinese US asset sales in favor of the UK and Europe: concerns over US equity valuations relative to the lackluster US growth outlook; a strategic desire to increase the global role of the RMB, and; perhaps not surprisingly, US political risk in a possible election victory by Donald Trump, the Republican presidential candidate. ***

*** Beijing, however, doesn’t see much political risk in OPEC’s efforts to stabilize oil prices. China expects to increase crude oil imports at an impressive 8% to 10% pace next year, and is forecasting Brent oil prices between $55 to $60, which aligns with Saudi Arabia’s target price range for next year (see SGH 9/23/16, “OPEC: Towards a November Output Deal”). ***

Reallocating Equities and Bonds

China has been quietly reallocating investments from the US towards Europe and especially the UK since the British voted on June 23 to leave the EU, something we noted barely days after the landmark vote (see SGH 6/27/16, “China: Supporting the UK after Brexit”).

Indeed, from what we understand, China’s state-owned financial institutions, led by the China Investment Corporation (CIC), sold a little over $65 billion worth of US equities and treasuries from late June to the middle of September. In turn, they purchased stocks and government bonds from the Eurozone, and especially the UK.

Those sales broke down on a monthly basis at $29 billion in July, $20 billion in August, and $15 billion through the first half of September. While these amounts may not be enormous in proportion to the capitalization of those markets per se, the reallocation is in fact the largest since 2005, when Beijing initiated currency reform and de-pegged the RMB from the US Dollar on July 21, 2005.

Breaking the numbers down further, the proportion of US equity sales out of the total (equity and treasury) sales for the same periods was for $11 billion in July, $16 billion in August, and $11 billion through the first half of September.

The volume of sales for the second half of September was estimated at the time to be even larger, at around $20 billion, although it is not yet known where that final figure ended up.

Persistent concerns among officials at the Finance Ministry and the People’s Bank of China over the lackluster pace of the US recovery and what it means for equity valuations are the main reason for the portfolio reallocations to Europe where better value is seen.

The PBOC and China’s state-owned financial institutions will continue to sell US treasury securities in an “orderly and continuous” fashion through 2016, not just for valuation purposes, but for strategic imperatives as well, as China pushes for a continued increase of the role of the RMB as a global investment and reserve currency.

Perhaps not surprising, there is also some lingering concern over US Presidential election risk as well. More specifically, there could be some degree of accelerated equity risk reallocation if the Republican presidential candidate Donald Trump wins the elections in November.

Crude Oil Purchases

Chinese officials expect GDP growth to remain within the 6.6-6.8% range next year, which will underpin demand for imports of crude oil.

Chinese officials expect oil prices to remain relatively attractive next year, and will thus look to continue their build-up in SPR stockpile supplies, as well as in commercial stockpiles.

In light of that, regardless of whether or not OPEC successfully limits production, and despite IEA predictions of the oversupply of crude extending into 2017, senior Chinese energy officials have told the leadership to expect China’s crude oil imports to grow at an 8-10% pace year over year in 2017.

Various government agencies predict oil prices will rise to $55-60 for Brent and $52-57 for WTI in 2017.

Interestingly, they also do not believe a December rate hike by the Federal Reserve – which they fully expect – will trigger anything like a global commodity price slump that it did in December last year.

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