Commodities analysts at ANZ Bank recently returned from a trip to China and they said that the mood there remains cautious. There are lingering questions about the new government and it policies and this is keeping business on a very short-term footing.
ANZ finds this all a bit disappointing, expecting more in the way of stimulus from Beijing by this stage. But instead, what we've been seeing is a push towards reigning in over capacity. This is serving to keep consumer inventories low, which in turn is acting as a dampener on demand. Tight credit conditions offer no help, making it tough for both consumers to buy and businesses to rebuild stocks.
In this environment, the bank is unsurprised by recent run of flat to weak economic reports.
The record high levels being posted by the Chinese steel market would seem to contradict the sluggish macro backdrop, but from what the bank has been hearing, current production is more than just consumption based. First quarter steel production was certainly better than hoped for and this should lead in to a slower than expected second half.
The good news is steel output growth for the year should still lift by around 7.0% over last year, which is at the upper end of market expectations. Thus demand for iron ore across 2013 should remain at least somewhat supported. But just like steel, most of this growth will play out in the 1H, with the 2H looking especially weak, meaning the seasonally strong fourth quarter could well disappoint.
The bank expects imported iron ore demand will fare better than domestic given higher availability. ANZ expects domestic supplies will remain tight given the new, lower price environment at which we are now looking. The bank also notes feedback from its trip, which indicates that new domestic iron ore supply won't be developed with an iron ore price below US$150/t. On top of that, with seaborne iron ore supply expected to significantly lift over 2013, especially from Australia, mills and traders will likely take advantage of this larger market.
Yet while iron ore demand has some support, the steel demand outlook remains mixed at best. Automobile output and transport infrastructure spend remains steady. The skew is towards passenger vehicles, with the commercial/industrial side feeling the pinch of slower industrial activity and weaker export orders. Highway and high-speed rail development is also running at a solid pace.
On the other hand, manufacturing, especially in heavy machinery and other export orientated steel goods is slowing. The stronger renminbi, especially against the yen, is also having a negative effect. Ship-building is soft and the ever important property market looks mixed, with strong public housing numbers offset by weaker private and commercial development.
Excess steel capacity remains a major issue, with feedback suggesting total annual steel capacity is around 1bn tonnes, while consumption is actually closer to 700m tonnes. ANZ notes most state run steel businesses are running at a loss right now, although it appears likely the government will be willing to keep writing this off in the name of social stability and employment. Likely a bigger reason is that these mills have large some loans and lower production levels would mean lower cashflow, which could cause banks to start calling in the debt.
We will likely see curtailment in privately owned small-to-medium-sized operations, but not at current steel prices, as most remain profitable. Margins in this segment are said to be running at around 3%, versus negative numbers at the state owned operations. The smaller outfits will also be very unwilling to give back share.
That being said, the little guys also sell on a much shorter term basis, so near term steel and raw material prices are crucial. Thus if the bottom does start to fall out of steel spot prices, output from this segment should quickly start to fall.
Inventory levels also present a slightly more complicated picture than would be normally expected. Steel stockpiles are declining, but only slowly and off of record high levels as recently as April. The good news is that iron ore stockpiles at steel mills are relatively low at around 20 days versus a more regular 30 days.
