A Chinese steel earnings index plunged nearly 90% this month.
Indeed, the margins are so bad that there are several reports that steel mills are now running their blast furnaces in slow motion and bring forward planned maintenance to limit their losses, adding downward pressure on the price of iron ore.
“The more you produce, the more you lose,” an international trader told Platts of the steel mills’ predicament.
The price slump – and additional pressure on futures prices, which are down nearly 3% – were likely compounded by China’s decision not to cut official interest rates, despite the dire economic downturn. which she faces.
But as Craig Botham, chief China economist at Pantheon Macroeconomics, notes, China’s decision to keep policy rates unchanged made sense given there’s little evidence anyone wants to borrow.
“The problem … is that monetary policy at this point is pulling a string. Rate cuts and liquidity injections only work if there is demand for credit, which is not being met because it is currently too expensive or too rare,” he says.
China is certainly not holding back its stimulus efforts, especially in areas where iron ore prices are most sensitive.
Approvals for infrastructure investment projects have tripled in a bid to revive this sector. And in the property sector, which is believed to account for around 40% of iron ore demand, officials are madly trying to reverse a crackdown on debt-ridden developers launched last year and revive sales.
Some 140 cities have reportedly released policies supporting property sales this year, ranging from easing restrictions on home purchases and lowering down payment ratios, to allowing interest-only repayment periods, through direct subsidies for the purchase of houses.
But the results so far have not been impressive. While home sales posted their first monthly gains for the year in May, volumes were still 42% lower than a year earlier. New home prices recorded their ninth consecutive monthly decline in May, while sales of existing homes recorded their biggest monthly drop since February 2015.
Uneven economic activity due to shutdowns and a lack of confidence in the essential real estate sector is not a recipe for demand or confidence.
Botham says that, as in previous housing slumps, household deposits are rising, suggesting precautionary saving. Companies aren’t too keen on borrowing either due to slowing growth.
“Absent stronger domestic demand, they have little incentive to borrow to invest, and most borrowing requests will be to meet short-term financing needs,” he says. .
And beleaguered property developers would love to get their hands on funds, but they’re not allowed to because the Three Red Lines rules, which place restrictions on developers’ debt levels, are still in place.
It remains to be seen how China will escape this slowdown. Ending the pandemic shutdowns will of course be important, but Botham says fiscal policy needs to do the heavy lifting.
“A successful fiscal stimulus would also boost aggregate demand and increase private sector demand for credit, making monetary easing less futile than it currently would be,” he says.
But increasing the demand for steel may take some time. And until then, steel mill margins and iron ore prices are expected to remain under pressure.
Of course, investors in BHP, Rio Tinto and Fortescue Metals Group need to keep this in context – even at current iron ore prices, the trio’s low-cost fundamentals mean they make huge profits and still have the ability to pay large dividends.
BHP’s cost forecast, for example, is between US$17.50 and US$18.50 per ton; in the context of a long-term iron ore price of around US$60 per tonne, these are very significant margins.
Still, miners have fallen since late April, with BHP down almost 25%, Rio down 15% and FMG down around 20%.
Until we learn more about the effectiveness of China’s stimulus pledges, the market may be cautious on the Australian resource giants.
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