Five ETFs Heavily Dependent On China

by on December 13, 2010 | ETFs Mentioned:

Over the last several years the economic growth gap between the world’s emerging and developed markets has gradually widened, as the U.S. and Western Europe face mounting debt balances and rising unemployment while the BRIC countries continue to expand at an impressive clip. This discrepancy has prompted a fundamental shift in the asset allocation process for many investors; the “home country bias” that historically prompted significant allocations to U.S. stocks and only minor weightings to developing economies has eased, with investors embracing emerging markets as a primary driver of both global GDP growth and asset growth within a portfolio.

Any discussion of emerging markets exposure will likely focus around China, which has seen its importance surge in recent years as it has emerged as a primary driver of global GDP growth. The current population sits at over 1.3 billion–the largest in the world–and still growing quickly. And while China is on the path towards becoming a developed economy, much of the massive country remains far below first world status. Currently, just 49% of the population is urbanized, but that number is expected to hit 80% by 2050. That translates into China adding commercial and residential space equal to the size of New York City every two years to keep up with the urbanizing trend. All the while, the economy of China is steadily growing, becoming a dominant global force [see also Three ETFs To Play The Coming Emerging Market Infrastructure Boom].

Currently, China’s economy is expanding at close to 10% each year, and according to an academic adviser to the People’s Bank of China the nation will maintain growth rates above 9% for at least the next decade. This growth isn’t solely a function of a growing population, which is expanding at a very moderate rate of 0.49%; a favorable demographic shift headlined by a swelling middle class is resulting in increased disposable income and greater local consumption. With millions of citizens moving to cities each year, China will need to rapidly expand its urban infrastructure in order to keep up with the waves of new residents.

The Chinese economy ranks as the second largest in the world, recently passing Japan and expected to surpass the U.S. by 2020, assuming that current growth rates are sustained. For the past three decades, China’s economy has exhibited an average annual growth rate of roughly 10%, though growth has slowed in recent years as the world has dealt with a crushing financial crisis.

There is no shortage of options for investors looking to gain exposure to China; there are currently 18 ETFs in the China Equities ETFdb Category that focus primarily on the Chinese economy. But as China has become an increasingly important component of the global economy, the impact of what happens in Beijing and Shanghai is now felt throughout financial markets. News of policy shifts or changes in demand in China reverberate through not only global equity markets, but can have a big impact on commodity prices as well. Below, we outline five ETFs that are heavily dependent on China, though they may not have direct ties to the country [see also Definitive Guide To China ETFs].

iPath Dow Jones-UBS Cotton ETN (BAL)

Cotton has been on the radar of many investors this year, as the fluffy commodity has surged for much of 2010.  China ranks number one in global cotton production as well as consumption, making the country a major price mover for this soft commodity. Price spikes have been fueled by hefty global demand, and supply shortages, all of which are centered around China. Due to heavy rains in 2010, crop yields in China have fallen well short of normal levels. China’s cotton output for 2010 is predicted to be roughly 18.5 million bales less than what is demanded by local markets, and this disparity may continue to grow if adverse weather persists. For the time being, China has continually paid the higher prices due to a desperate shortage of the commodity, helping to further cotton’s price spike [see What Cotton’s Surge Means For ETF Investors].

As cotton prices have spiked in 2010, BAL has reaped the benefits. This ETF tracks an index consisting of one futures contracts on the commodity of cotton, and has gained close to 60% this year [see BAL's fundamentals here].

Market Vectors Coal ETF (KOL)

China is rich in numerous resources, and coal is one of the country’s most strategically important commodities. When it comes to global production and consumption of coal, China leads the way in both categories. Coal accounted for 80% of China’s energy consumption in 2007, and will continue to be a major power source as the country’s economy continues to expand. Though China is making an effort towards clean energy, coal consumption is likely to account for a major portion of “market share” for the foreseeable future, especially if industrial expansion continues. In 2009, China produced 2.96 billion tons of coal and demand for this year is expected to eclipse the 3 billion ton mark, making this country both a major producer and import giant when it comes to the energy packed mineral. [see also Mining ETFs: Eight Ways To Play].

KOL tracks the Stowe Coal Index, which offers exposure to publicly traded companies worldwide that derive greater than 50% of their revenues from the coal industry. China makes up over 23% of this ETF, but the nation’s impact on the fund is even more significant than that. As the world’s largest consumer, trends in the Chinese economy will heavily weigh on U.S. outputs, and the U.S. makes up nearly 50% of the fund. While the fund’s holdings are not specifically dedicated to any one country, China will be a major mover behind the coal ETF in years to come.

iPath DJ-UBS Copper ETN (JJC)

Copper is yet another commodity for which China accounts for a big portion of global demand; the country leads the world in both copper consumption and production. Chinese demand for copper accounts for roughly 40% of the global total–nearly three times the level of demand of all of North America. Copper’s uses include a wide variety of economic necessities: plumbing, electrical power, power utilities, telecommunications, industrials, automotives, and cooling. In a rapidly-developing and rapidly-industrializing economy such as China’s, these services are in high demand, translating to a hefty need for copper. Aside from China’s massive demand, the nation also accounts for over one-third of global copper production, again making the nation the primary movers of yet another global commodity [see Behind The Copper ETN’s Impressive Rally].

JJC tracks the Copper High Grade futures contracts traded on the COMEX. JJC has returned about 10% on the year, often exhibiting big swings over a short period of time. In addition to this futures-based ETF, both iShares and JPMorgan are planning to release physically-backed copper funds, which could obviously expand the options available for investors seeking exposure to the critical industrial metal.

Market Vectors Steel Index ETF Fund (SLX)

Steel is yet another market for which the demand side of the equation revolves around China. In 2006 China, the world’s largest steel producer, exported over 419 million tons; that figure that dropped to 59 million tons in 2008 due to global economic hardships and a greater need for the sturdy metal on the home front. Despite a lower output, China still accounts for approximately 46% of global steel supply now. Much like coal, the majority of steel production comes from small-scale producers in China, meaning that steel affects both the big and small businesses of the country. As the world’s leading producer, any kind of snags in the Chinese supply chain could have drastic effects on the rest of the world. Of course, in an economy growing as fast as China’s, it should come as no surprise that the country is also ranked first in steel consumption; demand increased 25% in 2009, while the rest of the world’s steel demand dropped by that same figure [see also Time To Buy A Steel ETF?].

Also involved heavily in steel production is iron ore. As the world’s leading steel producer, it makes sense that China also leads the way in iron ore production. But, China’s appetite for iron ore outweighs its production, forcing it to import a large amount of the metal. This makes China the biggest mover of iron ore, which is one of the crucial materials needed to produce steel.

SLX measures the NYSE Arca Steel Index, which provides exposure to publicly traded companies primarily involved in a variety of activities related to steel production, including the operation of manufacturing mills, fabrication of steel products, or the extraction and reduction of iron ore. Though SLX has little direct China exposure, the country’s considerable steel demand and output will no doubt have a major effect on this ETF.

United States Oil Fund (USO)

China is now the number two crude oil consumer in the world, behind only the U.S. Oil is also the number one commodity import for the entire country, creating a reliance on petroleum-rich regions of the world. China’s 2010 demand for crude hit 9.1 million barrels per day, compared to the 19.6 million barrels that the U.S. uses on a daily basis. Currently, 32% of the oil consumed in the nation is imported, with the majority coming from the Middle East. While China is still a ways behind the U.S., their demand for oil grew by a whopping 37% this year alone, and the past five years has seen an increase in consumption of roughly 6% annually. This is important because although China does not consumer anywhere near the amount that the U.S. does, its growth rate is substantially higher and it will likely overtake the U.S. at some point in the future [see also Ten Commandments Of ETF Investing].

USO is one of the more popular ETFs, with an average daily trading volume nearing 10 million shares. The fund measures future contracts for light, sweet crude oil traded on the New York Mercantile Exchange, and has been on a tear as crude prices have climbed towards $90 [see more on USO's fundamentals]. Going forward, the level of Chinese demand will be a major driver of oil prices.

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Disclosure: No positions at time of writing.