Bloomberg

(Bloomberg) -- To picture the current state of the metals and mining sector, conjure up an image of a guy surrounded by a boisterous crowd chanting: "Drink! Drink! Drink!"

The guy in the middle is China.

The commodity-consumer-in-chief released a slew of economic figures on Friday. You'll no doubt be stunned to learn that second-quarter GDP came in bang on Beijing's target.

The more pertinent data for the metal heads, though, concern the amount of credit being pumped into China's economy. Tom Orlik, chief Asia economist for Bloomberg Intelligence, sums it up this way:

Aggregate financing rose 1.63 trillion yuan ($244 billion) in June, topping all 29 analyst forecasts in a Bloomberg survey. That means last month alone saw new credit exceed the 2015 GDP of Chile, Ireland, or Vietnam.

Patriotism dictates that I welcome the idea of another Ireland just popping up, but even I concede that one is probably enough. And this is the paradox of China's current growth model for the metals market: It is boosting demand while simultaneously eroding the foundation of that demand.

China's debt levels are high already, estimated at roughly 2.5 times the size of the economy at the end of 2015.

That's on par with the U.S. The difference, as Chris Watling of Longview Economics points out, is that the Chinese economy is at a far different level of development and the boost provided by credit is fading over time. According to Watling, it took 1.5 yuan of credit growth to generate 1 yuan of GDP between 1996 and 2008. Since 2013, that ratio has risen to 4.

Part of the problem is the continued reliance on old stalwarts of the Chinese economy, namely construction and state-owned enterprises. In the latest chapter of the Chinese ghost cities thriller, a new report by the country's National Development & Reform Commission found that small- and medium-sized cities were planning new areas that by 2030 could accommodate 3.4 billion people -- enough to house all the Chinese plus several hundred Irelands. Meanwhile, investment by state-owned firms appears to be crowding out the private sector.

Beijing knows this is unsustainable but it also doesn't want to risk a hard landing after years of rapid expansion underpinned by heavy investment and credit growth. It's notable that the jump in credit in the first half of this year came on the heels of what looks like an outbreak of labor unrest.

All of which provides a boost to metals prices and mining stocks, but a fragile one. Movements in the prices of industrial metals have tracked the rise and fall of Chinese credit pretty closely over the years.

Credit expansion in the middle of the last decade and, especially, in the wake of the financial crisis did wonders for metals bulls. But you can also see that the bang per buck has been fizzling in recent years, mirroring the trend of needing ever more credit to squeeze out an extra yuan of GDP.

This latest bounce in metals prices actually looks pretty modest compared to history. Yet it has boosted mining stocks inordinately, especially those of more leveraged companies like Freeport McMoRan and Glencore.

If you're banking on China keeping this going with ever bigger doses of credit, just remember: Keep drinking.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Liam Denning in San Francisco at ldenning1@bloomberg.net.

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net.

©2016 Bloomberg L.P.

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