China’s growth numbers were out yesterday afternoon and were very interesting indeed for the commodity analyst. The headline numbers looked out of this world on base effects, even year-to-date numbers. Fixed asset investment was up 35%. Industrial production up 35.1% and retail sales up 33.8%:
However, these numbers are going to tumble all year as the base effects wash out. Rather than go through each one in terms of actual aggregate numbers, let me show you the most important for bulk commodities which is real estate.
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Sales were also booming year to date:
And, new starts by floor appear to be off the chart as well year to date, up a crazy 62%:
But, if you look through the base effects to the underlying numbers by comparing this year to 2019 instead of 2020, the situation changes radically for the worse. New property area starts were down 9% in January and February versus two years ago:
Now, when we look at the stock of total floor area under construction, we still get a very distorted picture because the base effect is still working here as well:
But this is a “pig in the python” as last year’s COVID-stalled construction starts resume alongside last year’s COVID-recovery new starts. This temporarily inflates the floor area under construction stock even though the flow of new starts this year has actually fallen sharply versus 2019.
In short, China has a construction cliff dead ahead as an accumulated backlog of completions catches up to recently falling starts.
Boosting the case for this bearish outlook, there is a clear policy reason for why starts dropped so sharply in early 2021. In January, China installed its “three red lines” policy for major developers. Previously from Societe Generale:
The “three red lines” policy
- The policy was proposed end-3Q20
- 12 largest developers submitted debt reduction plans end-Sep,detailing how they will reduce their borrowing within one year andto fully meet the targets within three years.
- In early Jan, it was reported in the media that the policy will beextended to cover as many as 30 key developers.•If implemented, well over half of the combined balance sheet of theentire real estate sector would face material deleveraging pressureover the medium term.
- Caps on banks’ lending to the housing sector. In early Jan, the PBoC/CBIRC announced caps on each bank’s lendingto the real estate sector, covering both developer loans andhousehold mortgages.
There will be notable imapct on growth, if implemented
- It is important to economic growth.
- Housing market activity directly accounts for c.10% of GDP. Linkages with upstream and downstream sectors further boosts its weight to 20-25%.
- Land sales account for 10% of infrastructure funding. Despite the switch to special LGB funding, its equity-like features could still make local governments cautious over project investment.
This “pig in the python” for construction also helps explain the insane run-up in Chinese steel output through H2 last year and January/February 2021:
To corroborate this thesis I have charted floor area completions versus starts. If it is true then we should see a falling ratio as completions fell with the pandemic and then see them spike through this year. So far that is roughly the pattern:
But, truth be told, completions data shows so little correlation with starts over time that I think we’re really stretching the viability of Chinese data here.
So, I can’t be sure, even if the thesis makes thematic sense.
If it is true, then steel demand is going to fall sharply before too long as spiking completions force down the stock of construction to meet the already falling flow of starts that is being strangled by “three red lines”.
Both steel and iron ore prices will then crash.