Ore gets another towelieing

So, as predicted, ore looks vulnerable and continued its weakness last night. The spot prices got whacked another $2.20, down 1.6% to $137.40. We are still some ways above the next chart supports at $130.80, the post rout lows of late last year:

Sadly for the miracle commodity, the 12 month swaps, which tend to lead the spot price, plumbed new lows some distance below:

Which, of course, breaches the first of the support lines described here yesterday at $125.43:

So now we look to $118.75 to arrest the decline.

Recently I linked an interesting supposition by Sober Look:

The [iron ore]chart shows that indeed we had a correction in the price of iron ore in October, but the index had since stabilized. With the Baltic Dry index no longer representative of global demand (at least not until 2013 when capacity is expected to stabilize), a better measure of demand is the price of iron ore delivered to China. And that index, while clearly off the highs, is certainly not falling off the cliff – for now.

There have been a series of marginal indicators recently showing that the worst of China’s slowdown is not yet behind us. We’ve seen a leak from a reliable source that electricity production has collapsed and imports did tank. Car sales are looking quite sick and now iron ore is sliding after its seasonal rebuild.

We know the early Chinese New Year is, in part, a cause and the January PMIs were decent. There is nothing yet definitive to hang our hats on but, at the same time, signs are mounting that China’s landing is not going to be without some bumps.

And let’s face it, should we expect anything else? If there is one thing that we know after the past few years, it is that housing busts are very difficult to control and generally involve long periods of balance sheet repair, as well as slowed growth. On that subject, Kate McKenzie at Alphaville has an interesting post today on what a “hard landing” constitutes:

As far as we can tell, the ‘hard’ bit of a hard landing, for most pundits, denotes some kind of point at which social unrest and/or a recession-style downward spiral of demand takes place. It’s not surprising that definitions of what that hypothetical point might be vary.

For one thing, China’s unreliable data gets in the way, quite, quite badly. As Stephen Green of Standard Chartered wrote to us:

Given slowing growth in the labour market it’s getting harder and harder to work out how many jobs need to be created.

The [government] has limited accurate info on the pace and scale of job creation and destruction.

Some GDP growth is really  job-creating (services), while some is really not (steel and aluminiuim plants), so its all but impossible to work out a crude equation of so much GDP growth equals so many millions of jobs.

So it seems reasonable that the analysts at Nomura, who are attempting to put a number on the odds of a hard landing, have adopted a cautious line. As their Asia chief economist Rob Subbaraman writes:

Our definition of hard landing is naturally subjective. There is no strict academic definition. What we have tried to define is an abrupt downturn in the economy that would be painful enough for the man and woman on the street to really feel it, ie unemployment to rise. We have tried to be conservative in that our definition of a hard landing would be a hard landing with little doubt. The rationale behind our definition are twofold:

Quantity: we know that China’s potential output growth is slowing (in part due to the demographics) and so we wanted to choose a max GDP growth rate that would without doubt be below a slowing potential growth rate, thus causing a severe recession and unemployment to spike. A decade ago it may have been 7% but with potential growth slowing today a max of 5% feels more about right. It would be equivalent to probably -2 to -4% growth in the US.

Duration: one quarter of a bit under 5% growth need not be a hard landing if it is followed by a snap back to, say, 12% growth the next quarter. Hence our definition of GDP growth averaging 5% or less over four straight quarters. It could be four quarters of 5% growth, or one disastrous quarter of, say, -2% followed by 5%, 8%, 9% – averaging 5%. Either a disastrous quarter (or more) or persistently weak 5% growth would, in our view, cause an unemployment problem in China over next three years (note the 1-in-3 likelihood we’ve attached is for the hard landing to commence before the end of 2014).

As the comments above suggest, there is a political and social element to this. If unemployment rises too much, the logic seems to go, the communist party’s authority could be seriously challenged. And then, who knows what it would mean for the banks, or the coddled state-owned enterprises? Or local governments? Or all those infrastructure projects?

We also asked Nicholas Lardy, a Peterson Institute fellow who has written several well-regarded books on China’s economy, for his thoughts on the concept of a “hard landing”. The subject isn’t addressed directly in his latest book, so we emailed him asking whether a deceleration in the apparent growth rate of urban wages (10 per cent on average) would constitute a “hard landing” — or if he believed the term was meaningful (this was without reference to any other particular analysts):

His reply:

I don’t think short term deceleration of wage growth would trigger unrest.  Although wage growth in real terms has been 10%, in 2009 there was little growth for large segments of the modern sector labor force.  But this episode was followed by above average increases in 2010.  But maybe sustained wage growth slowdown would trigger unrest, this hasn’t been test recently.

He goes on to say (emphasis ours):

I don’t like the term hard landing because sometimes users of this term imply that the economy would fall sharply and then quickly bounce back.  I think the greatest risk now is a sustained slowdown lasting a couple of years, perhaps even longer.  If property weakens further it will have widespread macro repercussions, even if there is not initially a strong knock on effect on the financial sector.  So growth over a period of about 2 years might slow to 7% plus or minus and then remain at that low level for a couple of additional years.  That would have major implications not only for China but for the global economy. But this path is not really captured in the phrase “hard landing.”

My take away is that such an outcome does not seem likely to be supportive of the current levels of commodity prices.

P.S. In case anyone is wondering, that is not a spelling mistake in the title.

David Llewellyn-Smith
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  1. Alphaville has an interesting post today on what a “hard landing” constitutes

    IMNSHO, my JAL flight 123 analogy was far more accurate. I picture Chanos’ famous “nine guys in a room” each with four or five levers to control, with sirens and alarms going off in the background, and an insistent “Pull Up! Pull Up!” from the PBoC mainframe.

    • Nice analogy! But let’s not forget that Air France 447 DID pull up,; that was the wrong thing to do as well, because they were already at stall speed, and nothing, bar knowing that and acceleration downwards, first, was going to stop them crashing,either.

    • Poor comparison – the JAL 123 pilots heroically kept the aircraft flying for 32 minutes after the loss of the vertical stabiliser.
      These people, on the other hand, have no clue.

  2. H @ H I wonder how you think of the outlook for the $A with these conflicting factors – iron ore falling, coal falling, base metals falling except say for copper and oil firming but carry trade in full force with 10% tax only for recipients and interest rates for lenders high and steady. Also threat and reality of QE or quasi QE in major currencies. However, finally people waking up to the destruction of business on the east coast particularly. Can the politicians, RBA and Treasury stomach what is coming with the carbon tax an unquantifiable deflationary/inflationary force yet to be really factored in?

  3. Very droll.

    Lets walk our way through this:

    My debate with you yesterday was not about whether the price will, rise or fall but whether the port inventories were an indicator or a driver of price movements. Nothing has changed in respect to that debate.

    SoverLook: pretty comment analysis actually. Since when would you ever choose the freight indicator over the spot price for indications of demand (for non-exchange traded commodities anyway).

    Zarathustra is the weakest blogger on this site. Daylight second. Factoids and anecdotes but devoid of credible analysis. When imports recover in Feb I hope your headline will be “Towelie Tipped It”


    But at least the article recovers with the good discussion from Alphaville.

      • So you don’t buy Grantham’s paradigm shift in the pricing of commodities, particularly stuff in the ground?

          • Intriguing isn’t it. If that is the case the whole MRRT fiasco and any forward planning based on revenue streams is blown to pieces. Some modelling has demonstrated MRRT voided by a 20% reduction in prices. Some might even suggest the that by 2016 it is entirely plausible that at best ‘negligible’ revenues are received.

            Back to the drawing board.

          • “$80 something in 2016 feels about right”

            That is $US you mean? That might be $A120 by then. So no change in price in $A.