|Summary: Concerns of a sharp economic slowdown in China, and a fall in steel production, persist. But if there is a slowdown ahead, it’s not readily evident as demand for bulk mineral commodities – particularly iron ore – remains strong. This is reflected in the higher quarterly ore production figures just reported by the likes of BHP Billiton and Rio Tinto.|
|Key take-out: The production surge that we are witnessing is being readily absorbed into the market without apparent distortions, or excess volatility. An ensuing period of price stability will help to enhance prospects, while contributing to a lower overall risk profile for our largest miners.|
|Key beneficiaries: General investors. Category: Shares.|
Major resource stocks have underperformed the market so far this year, with falls for some of the major stocks (such as BHP Billiton, Rio Tinto and Fortescue) up to 8-9%. Not that the All Ordinaries has had a great run mind you, although gains are still there (1.7% so far).
Part of that underperformance obviously has to do with persistent concerns over China. At the same time though, the underlying fundamentals have improved quite dramatically. BHP’s latest production report released last week showed some very strong lifts in output. Iron ore and coking coal were both up more than 20%!
This is the volumes story that we’ve known about for some time. Production is surging, although invariably some commentators even put a negative spin on that in saying we’re going to have a supply glut or Chinese demand will slow as its economy slows. The truth is, too much is made by some of China’s slowdown in growth, suggesting a credit bubble. For practical purposes these discussions are irrelevant – as we are seeing – as there is never much in the way of supporting evidence. Indeed, through it all, China continues to import huge and growing quantities of iron ore and other commodities.
I’ve written about the reason for this before, and nothing has changed (see Iron story is ore inspiring). As a brief reminder, demand for iron ore and coking coal will be supported by several factors:
- China’s ongoing urbanisation.
- A construction upswing in Europe and the US.
- All of which supports strong demand for steel – and so iron ore and coking coal demand.
Now there are a few developments to note in regard to this view though. Only two weeks ago, the World Steel Association downgraded its expectation for global steel use in 2014, from 3.3% to 3.1%. Within that it confirmed an expectation that apparent steel use in China will slow sharply in 2014 to 3%, from 6.1% in 2013. Recall that China is the world’s largest consumer (and producer) of steel.
Noting this, China’s economic growth numbers released last week are interesting – especially the data that shows fixed investment is still surging. It is growing at an annual rate of 17.6%. Sure, that is slower than the 20% rate we saw through 2013, though not markedly. Indeed, private investment is still growing at a 21% annual pace and this is not much changed from the rates of 23% we saw through 2013.
It’s interesting because it implies that the World Steel Association’s forecast for steel use in China is excessively bearish and, for me, unlikely to materialise. The key reason for that is because it reflects what is clearly a false paradigm in China – this persistent and unfounded pessimism on China. For instance, back in 2012 the World Steel Association expected apparent steel use in China to slow over 2013 to 4%. This was due to a “less steel intensive growth phase, with the government’s efforts to rebalance the economy and contain the real estate bubble.” Instead growth was more than 6%. In 2014, it’s the same. Growth in China’s apparent steel use is expected to halve because “the Chinese government’s efforts to rebalance the economy continues to restrain investment activities.”
I’ve noted before that the desire to rebalance China’s economy is less a Chinese policy goal and more a wish of the United States. The US would dearly love export and investment-led growth such as we see in China. Instead, growth in the US is driven by consumers and debt. The US very publically (the official policy stance) blames other nations for this consumer debt-driven growth however, and often complains that other counties like China – and Japan and West Germany in the 1980s – don’t do their bit. That’s not to say China doesn’t want changes. The government there certainly does, and what it wants to achieve is slower and more sustainable growth – of about 7% to 7.5%. Anything much more than that – for a $10 trillion economy – would be a disaster for China and the world. This idea that China wants to rebalance away from export and investment-led growth – which is what every western country now seems to be aiming for – is not likely though.
So can we expect fixed investment growth rates – and steel consumption – to slow sharply from here? A bit yes, but only a bit, which is consistent with the Chinese government’s policies. Yet, I don’t think this will be sufficient to see apparent steel use growth rates halve. That leaves ongoing strong steel use in China and an expected surge in steel use in Europe and the US for this year and next (see table 1 below). On that basis, demand for our key bulk resources is unlikely to wane.
With that in mind, the main uncertainty I see for the resources sector, and in particular for our major miners, is the price of bulks (particularly iron ore). It’s been a volatile old time with the range over the last year for iron ore at about $35, or 26%. We saw another decent sell-off only last night, with record level stockpiles the apparent driver. More broadly the last three months has been quite different, though with prices (spot prices shown, which is just over half the market) seemingly much more stable – something largely replicated in the coking coal space as well.
I suspect much of this stability stems from the apparent ease at which the market has absorbed a surge in supply – a glut some have called it. Certainly the Bureau of Resources and Energy Economics expects coking coal prices to stabilise and perhaps even increase, noting: “Metallurgical coal contract prices are forecast to rebound in 2015 as a protracted period of oversupply comes to an end through demand catching up and the closure of higher-cost mines reducing world supply”.
A similar dynamic will/is likely taking place in the iron ore market, with the world’s largest iron ore producer – China – likely to see the closure of higher-cost Chinese iron ore mines and facilities. It’s against that backdrop that I don’t think record level stockpiles of iron ore are anything to be concerned over.
To conclude, prospects for the resources sector remain very bright. The production surge that we are witnessing is being readily absorbed into the market without apparent distortions, or excess volatility. An ensuing period of price stability will help to enhance prospects, while contributing to a lower overall risk profile for our largest miners. All of this will add to the growing attractiveness of the sector, which on some metrics looks quite cheap.