Tangshan, a sad, sad place. In November 2011 I visited a range of steel mills and traders in Tangshan (population: 7.5m), a dreary, heavily-polluted Dickensian 3rd-tier city in Hebei Province (2-3 hours drive from Beijing).
Tangshan is famous for its steel industry, which officially produces around 90-100mtpa (out of China’s total 700mt), though local private mills said Tangshan’s total capacity is more like 120mt. Tangshan is also famous for a large earthquake in 1976 which killed 300,000+ people.
It was a very bearish trip and everyone we met expected further falls in steel and iron ore prices. However, noone we met forecast the lows of Sep 2012, when the iron ore price fell below $90/t.
Philip Wen published a piece in the SMH today about the rebound in the iron ore price from sub-$90/t in Sep 2012 to $158/t, asking the pertinent question: “Is this spike ‘one last hoorah’ for iron ore?”
The iron ore recovery will certainly put a smile on the face of Aussie iron ore producers and is a positive sign for Chinese economic growth. But how sustainable is the recovery?
Monthly survey: To gain a bottom-up view of what’s actually happening, I interviewed a Beijing-based commodities analyst who is constantly tripping over scrap steel at mills all over China. As such, this analyst has a real feel for the pulse of the Chinese steel and iron ore markets.
She expects higher steel and iron ore demand over the next 6 months, with steel reacting earlier than iron ore. Her reasons include:
- Destocking cycle over: 2012 was a year of thorough destocking and the cyclical destocking of steel and iron ore is over.
- Low base effect for year on year growth comparisons.
- Low customer inventories: Steel trader and end customer inventories are very low, so restocking is occurring.
- Iron ore supply not strong.
- Macro support: According to the analyst, “the new leadership wants urbanisation and stable growth before consumption can pull up its share of growth…investment has to be strong for the next 2-3 years to buy time.” ie. The Government will be following the tried and tested, but ultimately flawed, Fixed Asset Investment model.
On actual inventory levels:
- Iron ore inventories are around 2 weeks at the steel mills and are around the same level as Q4 in 2011 – which was a real time of doom and gloom, as per my Tangshan visit.
- Steel inventories are currently lower than 1 year ago.
Undecided on thermal coal however, due to high inventory.
“I’m more on the fence for coal. In 9 months we should see the [thermal] coal price bounce back. But in the short term there is still way too much inventory…not sure how long it will take to destock and not sure about the magnitude of demand recovery of power and industry. Leaning towards price recovery in 6 months, but later than steel and iron ore.”
Though the analyst notes that the railway transportation bottleneck is still tight for 2013, so this will provide a floor for the thermal coal price. However, the seaborne Newcastle thermal coal price is still trading at a sub-$100/t level and hasn’t rebounded as much as iron ore.
More positive macro view: “Materials and industrial companies will likely feel better as activity levels are up. Those who destocked last year will benefit more and those not done destocking, will continue to destock.”
Expectation of looser monetary policy: The analyst argued that monetary policy had to be expansionary to fund investment: “…there is no other way than pumping more into the ‘total social financing’ numbers in 2013 to fund these projects.”
Following on, there will be greater credit demand, with higher SOE project-related demand. She is not seeing a slow down of investment appetite in steel, but notes that some industries like heavy machinery plants are not looking to expand capacity.
But unsure of private credit demand: She is unsure if the private sector will have a similar appetite for credit demand – this will largely depend on how far they have destocked.
So in summary, the outlook for bulks is positive in the short-term, mainly because China’s FAI addiction will continue. However, I agree with Credit Suisse’s assessment (as reported by the SMH), that bulk commodity prices will likely recede in the second half of 2013 (though thermal coal may be more of a laggard).
The long-term is negative for iron ore, but potentially positive for some metals: If China ever gets serious about weaning off FAI-led economic growth and shuts down all of its excess steel capacity (a big ask given the role steel mills play in providing local employment), this is negative for iron ore demand.
But it doesn’t necessarily mean that Chinese commodity demand will fall.
If China does make the transition to a more consumption-led economy and moves higher up the value chain, look out for strong demand and diplomatic spats for metals important in robotics and fancy manufacturing processes, like rare earths.