The answer to that seeming disconnect may be over-optimism in China’s steel industry, which ramped up production even as Covid-19 was hobbling the economy. Crude output of the metal was around 2.7 million tons a day in January and February, but then increased to 3.1 million tons a day in April and May, Gavekal Dragonomics said in a note on Monday.
“The decision to operate at high capacity even after lockdowns hit growth suggests firms are also betting that a rebound in infrastructure and property will sustain demand,” Gavekal analyst Rosealea Yao said in the note. “Although infrastructure spending has picked up this year, the property sector, which accounts for 39% of total steel consumption, has failed to fully recover and prospects are uncertain.”
The steel-making ingredient is widely expected to reverse direction at some point, but the big question remains when. The charts below show the challenges it’s facing:
A Bloomberg gauge of the profitability of Chinese steel mills has plunged this month to the lowest level in five years. In the northern steel-making hub of Tangshan, companies are responding by going into maintenance and cutting output. Profits have fallen because production was kept at high levels even when demand was weak, Erik Hedborg, principal steel analyst at CRU Group in London, said in emailed comments. “Our internal modeling shows that steel margins in China have been negative since the beginning of April.”
There was a big run-up early in the year in inventories of steel products used in construction, such as rebar and hot-rolled coil. The over-production has meant that they’ve stayed high, and have actually started expanding again in recent weeks. Demand for iron ore will likely remain subdued until there’s a meaningful decline in those stockpiles, which will be dependent on the property sector and the pace of government infrastructure spending.
Here’s the money chart from Gavekal:
So, will iron ore rebound in H2? As said yesterday, there is some seasonality at work in southern Chinese rains so it’s possible in the short term. But that does not mean that the correction is over. Why would it be given China has the largest inventory of steel for this time of year ever, steel margins are in the toilet, its raining iron ore as miners chase volume targets, and this:
Yes, there’ll be some infrastructure, but not enough.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
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.
