Emerging markets currencies endured an evil beating Friday as global markets adopted a decidedly "risk-off" tone. There were many causes of the sell-off, but weak economic data from China played an important role.
For Canadian investors, the apparent end of emerging markets outperformance has huge implications. Specifically, investors in the domestic mining sector should cherish their memories of the 2009 to 2010 boom, because it's unlikely things will ever be that good again.
The chart shows how, in hindsight, the Canadian mining sector was easy money in mid 2009. Mining stocks were cheap, which made for a lucrative jump off point. But the big catalyst for the sector was an aggressive monetary policy in China. The Chinese government made a determined, sustained effort to restore economic growth by fully opening the spigots on credit.
S&P/TSX Diversified Mining Index vs China M2 Growth
SOURCE: Scott Barlow/Bloomberg
It took about 12 months for the Canadian mining sector to feel the positive effects from Chinese policy. Under direct orders from the federal government, Chinese banks beginning in early 2009 started handing out loans to any local businessperson that asked.
Given the stage of China's economic development, the majority of these funds were used for infrastructure and residential real estate construction. The result was a huge surge in commodities used to build things – copper, steel, coal, and the crude oil necessary to power the heavy equipment.
To say that China's credit boom, and the surge in commodity demand that resulted, was beneficial toward Canadian miners is a massive understatement. Starting in September 2009, the S&P/TSX Diversified Mining index started a rally that saw stock prices climb 341 per cent by January 2012.
China's credit and monetary growth is still significant, but well below the unprecedented levels of 2009 that dragged the mining sector out of its crisis-induced mire. Unfortunately, the current 14 per cent growth rate for China's money supply has been consistent with negative year over year returns for the broader mining sector.
I'm not suggesting every Canadian mining company will file for bankruptcy. Though China is the world's second largest economy, it's not the only country that needs resources for growth. A resurgent U.S. housing industry, for example, could replace a lot of the copper demand lost as Chinese growth slows.
It's also good news that the close relationship between China's credit growth and domestic mining stocks has been fading a bit. The coefficient of correlation – mathspeak for "the extent to which two lines move together" – peaked around 0.9 in 2012 (1.0 is a perfect match). Lately it's been averaging around 0.45-ish, which is not really statistically significant. The fading correlation could be a sign that the mining sector is less dependent on China.
Still, the volatility in emerging markets assets this week is not positive for the mining sector. If global growth continues to shift to developed markets, sectors like technology, industrials, and retail are likely to take over market leadership.