Winter came early to the Chinese commodities space

By John Guise

Photo by Ernie, via Flickr.The onset of winter is usually mild in the majority of China, but that had not been the case for the country’s resource sector this year as fall drew to a close. The Middle Kingdom’s stagnant property market has cut much of the country’s demand for steel products. This has caused a drag on much of China’s manufacturing sector and the overall economy.

Property sales dropped by 10.6 per cent year-on-year in September, emphasizing the weak market. Sales fell by only 1.6 per cent year-on-year in October. However, this moderation may be due to Beijing’s loosening of mortgage rules, which buyers back to the market.

However, whether this will cause a rise in new housing construction remains to be seen. Therefore it’s hard to tell at this point if it will cause a pick up in steel demand. If one studies the raw material buying patterns of Chinese steel mills, it seems to indicate those mills don’t seem to think so. According to The Steel Index, 62 per cent iron ore fines for immediate delivery to China was selling at US$75.50/tonne, one of the commodities’ lowest levels since 2009. Mills’ crude steel production also reflects this. According to the China Iron and Steel Association (CISA), its member mills produced 1.635 million tonnes between November 1 to 10, down 1.8 per cent from the last 10 days of October.

If mills were simply waiting for prices to drop they would be purchasing the commodity in at least modest numbers. The $70/tonne level is considered the point when domestic Chinese mills will shutdown and is therefore considered the floor for the material. The fact that mills are not buying now shows how difficult domestic conditions are for mills. It also reflects the impact of China’s credit tightening policies after a metal trading scandal at the port of Qingdao, which came to light earlier this year.

Iron ore traders are expecting mills to start buying soon however, especially for Northern Chinese mills which had to shut for the recent APEC summit. Stocks at Chinese ports rose 1 per cent to 107.4 million tonnes on November 7th after five weeks of declines according to Steelhome.

But iron ore prices are unlikely to rise any time soon. This is because miners such as Rio Tinto and BHP Billiton are bringing on stream many of their new mine projects, which were being developed to supply Chinese demand. That will likely keep prices for the material at around US$78/tonne in 2015 down from an earlier prediction of US$101/tonne according to the Australia New Zealand Bank (ANZ). In 2016, ANZ analysts predict prices will be around US$85/tonne and rise to US$89/tonne in 2017.

Miners are not worried, however, as they believe the market will go through peaks that will absorb the extra supply.

And they may be right. The absorption may just be masked by low prices. The parties buying the cargo may also be different than what one would expect. The party buying the cargo is not mills but traders. The same Steelhome report cited above actually says that Chinese port stocks as of November 7th were up 24 per cent year-on-year.

Chinese steelmakers that are buying ore from traders are likely sending their finished products overseas. According to CISA, the country’s steel industry has exported 80 million tonnes of steel this year. The markets that appear to be buying include the US, India and Taiwan.

While that might have taken some pressure off of producers due to a weak domestic market it might ignite trade wars with other countries. That could include India which is currently debating whether it wants to allow Chinese steel to be used in its domestic infrastructure improvement program which is using to boost its own economy. Chinese mills might also eventually price themselves out of the market as observers say they are rapidly slashing prices in an effort to get orders from overseas buyers.

The impact of these overseas exports and what their effect will be on China’s domestic steel market and its raw material buying will be the focus of my next Resources Quarterly column in Spring.

Resources Quarterly - Winter 2014-2015
This article originally appears in the Winter 2014-2015 edition of Resources Quarterly.

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