Let’s party! Yes, it’s a world party and we’re all invited. At least, everyone else is. I’m sober, and, like some stale chaperone, worried.
Still, let’s face plant into the punch before we call the police. Preliminary US Q3 GDP came in at 2.5%, right on expectations. Here’s the chart from Calculated Risk:
This is an advance estimate and these tend to be revised down. Nonetheless, it’s a damn sight better than it looked like delivering six weeks ago. So bravo.
Still inhaling on the sweet Latin nectar, and the Eurozone fix, such as it is, has reconfigured the macro settings on the bullish side for now. The $US was smashed last night, returning us to the post Bretton Woods II growth dynamic that has kept the world economy going since 2009. That is, a weak dollar boosting external demand for the US, and creating capital flows into emerging markets which boost their domestic demand as well as their exports to the US, and inflate commodities. In short, the virtuous cycle of undollar love.
But, sadly, gargling around the punch, I mentioned emerging markets. And it is here that the party comes to an abrupt halt. Something has gone badly wrong with China’s other growth engine, fixed asset investment. And, as we shunt backwards from the bowl, and wildly shake the punch from our hair, spraying the room with scarlet droplets, we can hear the approaching wail of a police siren coming to ruin the evening.
The culprit is iron ore, down another 5.7% yesterday to $120.20. 12 months swaps hit a new low of 115.89 down 1.37%. Meanwhile, Shanghai rebar was down a smidgen, 0.23%. Seems to me, we’re in danger of a contango in iron ore, which would be a first.
The culprit is not hard to find. From the FT:
Chinese metals companies, lynchpins in the global economy, are warning that Beijing’s monetary tightening has gone too far, causing domestic customers to delay orders and raising the risk of payment default.
In one of the clearest signs yet of deteriorating sentiment, Baosteel, China’s second-largest steel producer, has told the Financial Times that its customers were pushing back scheduled deliveries “due to declining economic growth and tightening credit”.
…China has tightened monetary policy this year in an effort to fight inflation, and those measures have started to cut into demand as construction growth slows. Nonetheless, the country is still buying vast amounts of raw materials, with copper imports hitting a 16-month high last month and annual buying of corn heading to its highest level in 15 years.
China’s large industrial groups are increasingly voicing concerns over the impact that credit tightening is having on their customers, after a year in which Beijing has raised interest rates and bank reserve requirements. Chalco, China’s biggest aluminium maker, said it was worried about payment defaults from credit-squeezed customers. “Because our downstream customers face the predicament of scarce capital, the company’s risks of payment collection are increasing,” it said this week. “We must pay great attention to this.”
China’s steel demand growth is expected to slow this year, and analysts say that mills’ miscalculations led to a glut of steel inventories building up in September, leading to a drop in steel prices during the past month.
Yes, it’s the hangover from the last undollar binge that we can blame, that has resulted in what looks more and more like a hard landing in China’s fixed asset economy. But there’s more. As the party goers awake bleary eyed, the wreckage of last night’s binge comes into focus. From Reuters:
While the central bank’s battle against inflation has choked off funding for new buildings, roads and railways, talk of Beijing adopting an easing monetary cycle or lifting property curbs is premature, analysts say, although authorities could seize the chance to force consolidation of the sector.
“Steel demand is very poor,” said Judy Zhu, an analyst with Stanchart Bank in Shanghai.
“There is hardly any restocking going on because buyers are cash strapped and there are growing worries of a further slowdown in the property sector.
“I don’t expect Beijing to start easing until early next year, which means it would be difficult for steel demand to improve markedly.”
UBS analysts said steel output growth in China could slacken to just 4.4 percent for a total 726 million tonnes in 2012, marking the weakest level since 2008 and down sharply from industry estimates of 11 percent this year.
Such a development, compared with some analysts’ previous expectations for growth of 7 percent to 8 percent, would cut previous output forecasts by about 20 million tonnes, which would in turn cut iron ore consumption by at least 35 million tonnes and coking coal by 13 million tonnes.
It certainly is too early to consider easing, that is if China is serious about containing its property prices, which have just begun to fall. However, steel based activity is falling very fast now, also according to Reuters:
China’s average daily crude steel output dipped to 1.7998 million tonnes over the Oct 11-20 period, the first time it has fallen below 1.9 million tonnes since February, data from the China Iron & Steel Association (CISA) showed on Thursday.
A growing number of Chinese steelmakers have begun overhauls at their facilities as they try to shield themselves from a steep decline in steel prices and a slowdown in sales, with Beijing’s tightening moves continuing to weigh on demand.
“Many steel mills have expensive raw materials, which they bought earlier at high prices, and steel prices have fallen rapidly entering October, so we are seeing more overhauls by steel mills as their margins worsen,” said Hu Yanping, an analyst with industry consultancy Custeel.com.
The utilization rates at 111 rebar and wire rod rolling mills in northern China’s Tianjin city and Hebei province stood at 75.2 percent this week, down 10 percentage points from a week earlier, a Custeel.com survey showed. CISA originally said that daily output in the first 10 days of October reached 1.934 million tonnes, suggesting the country’s mills were still producing at very high rates despite the woes facing the sector.
But according to the association’s latest data, accumulated output over the first 20 days of October stood at 36.357 million tonnes, indicating that it has revised its output numbers for the first 10 days of the month to 1.836 million tonnes, according to Reuters calculations.
And here is the CISA weekly output data showing the sudden declines:
Meanwhile, as nauseated party goers stumble out of the building, the iron ore majors are still boozing. Again from Reuters:
Brazilian mining giant Vale joined its rivals in pledging on Thursday no let up in iron ore production, even as prices slump, European buyers cancel cargoes and Chinese steelmakers clamor for price relief.
Signaling a firm belief that the nearly 30 percent slump in spot market prices this month is a temporary blip, executives of the world’s biggest iron ore producer said Chinese monetary policy easing should help bolster demand from its top consumer.
Vale also confirmed further changes in the way iron ore is traded, saying the company that first broke the age-old annual contracts system is now in talks with customers to move from quarterly toward spot pricing. “We do not plan to make any cuts to production,” said Chief Executive Murilo Ferreira in a conference call with reporters. “Vale is one of the companies with the lowest production costs. If anyone is going to shut production, it will have to be those with high production costs.”
The comments, a day after Vale’s earnings missed analysts estimates due to a drop in Brazil’s currency, show the company defiant in the face of skepticism about China’s iron ore demand and worries about global economic growth.Company officials said earlier on an earnings conference call that Vale is sticking to its planned production targets of 310 million tonnes for 2011 and 320 million tonnes for 2012. Australian rivals BHP Billiton and Rio Tinto have also said they plan to keep ramping up output.
And the famous party animals of Brazil are getting a run for their money from the hard-drinking sandgropers. From BusienssWeek:
Fortescue Metals Group Ltd., Australia’s third-biggest producer of iron ore, said prices for the steelmaking ingredient won’t drop much more from their lowest level in 15 months.
“I don’t think they’ve got much lower to fall,” Chairman Andrew Forrest said in an interview with Bloomberg Television yesterday. “China has deliberately slowed its own growth to allow its economy to catch up to keep inflation down. You’ll still see growth rates going from 9.7 percent to 9.1 percent. That’s still massive growth.”
…“It’s all about China restricting credit,” Forrest said on the nation’s economic slowdown. “The steel mills have acted in collusion in China. That’s probably spooked a couple of Australian producers or international producers into having to compete with each other.”
BHP Billiton Ltd., the world’s biggest mining company, last week said the slump in prices was due to flagging demand from European steel mills while orders from its largest customer China have so far been unaffected.
“In China overall, which will over the long run be the driver of prices, we have not seen anything really happening there yet,” Marius Kloppers, BHP’s chief executive officer, said Oct. 20.
ArcelorMittal, the biggest steelmaker, has idled plants in Luxembourg, France, Germany and Spain in the past two months.
The European fix does nothing for its economy beyond a short term confidence boost. There’s likely to be no turnaround in steel demand there in the near future. I do expect China to ease by year end. But if they are serious about containing real estate prices, which they seem to be, easing will have to be paced with declines, not a bounce back.
For now, at least, the problems confronting the infrastructure real estate sectors are mounting not falling. Despite the bravado, the iron gut party-goers will likely be forced onto the wagon before they can binge again.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.