Resilient iron




In a surprising turn of events, the commodity that should be bearing the brunt of China's deepening property crisis is instead displaying remarkable strength. Iron ore recently reached its highest point in a month, defying the shadows cast by China's debt-laden economy. Despite waves of disconcerting news from the real estate sector, which usually constitutes about 40% of iron ore demand, prices have largely held above the pivotal $100-per-ton mark this year.

This defiance of a price collapse or a sharp reduction in steel demand highlights how certain segments of China's economy are weathering the storm amidst the bleak headlines. While challenges remain for iron ore, including the potential for a prolonged property sector slump, the relatively robust prices present a counterpoint to the prevailing bearish sentiment permeating Chinese markets.

Chief Economist at Grow Investment Group, Hao Hong, notes, "Iron ore is still very resilient for an environment like this, and I think Chinese demand is playing a role in that." This resilience suggests that sections of the economy, beyond the troubled property sector, remain in relatively good health.

While the Shanghai Composite Index experienced its lowest point this year, prompting government interventions, iron ore futures climbed to $114 per ton. This stands in stark contrast to the major slump witnessed in 2015-16, when prices plummeted below $40 per ton, contributing to trade tensions as China flooded the global market with steel surplus.

However, this doesn't imply that China's economy will evade a significant growth slowdown, nor does it guarantee sustained high iron ore prices. Construction in the property sector is contracting, especially in less developed inland cities. Additionally, the Chinese government, under President Xi Jinping, is refraining from extensive stimulus measures, including infrastructure spending, which historically boosted steel consumption during economic strains.

Major iron ore producer BHP Group reported "solid demand from infrastructure, power machinery, autos, and shipping," offsetting weakness in housing starts and construction machinery. The consultancy Kallanish Commodities Ltd. adds "white goods" to the list, encompassing items like refrigerators and washing machines.

In contrast to local governments curtailing spending due to financial constraints, central government investment in infrastructure, particularly railways, is accelerating. Spending on railways has grown by 25% year-on-year in the first seven months of 2023. Machinery manufacturing and auto output have also witnessed growth. The new energy sector is experiencing a boom, further contributing to steel demand. However, property investment contracted by 7.1% in the first seven months of the year.

Steel industry forecasts from CRU Group emphasise the divergence between construction and other sectors. Demand for "long products" utilised in construction is projected to decrease by 1.7% this year, while flat products are expected to see a 3% increase.

While the property sector continues to grapple with debt risks, some state-backed developers report a revival in sales volumes, offering glimpses of optimism. Overall, the market appears to be "lying flat," according to Jiang Hang from Yonggang Resources Co., suggesting that mills are keeping minimal inventory but purchasing when immediate demand arises.

The resilience in steel demand and iron ore prices is attributed to various industry-specific factors. Steel exports have absorbed additional material, with China's shipments on track to reach levels not seen since 2016. Iron ore has also benefited from reductions in electric arc furnace use, an alternative steel production method. This has sustained robust iron ore-derived output.

Steelmakers and traders are stocking up on iron ore in anticipation of the seasonal construction activity lift after the summer. Moreover, mills might be increasing production to guard against potential government-mandated production curbs later in the year.

Xu Xiangchun, an analyst with Mysteel, acknowledges that iron ore prices have slightly strayed from economic fundamentals due to the lack of discipline at mills. He notes, "China's economy isn't that promising."

For the remainder of the year, whether China can evade further turmoil in the property sector will be pivotal for iron ore prices. The lack of confidence in the private sector, coupled with the risk of local-government debt stress spreading, presents formidable challenges.

Tomas Gutierrez, an analyst at Kallanish Commodities, observes, "China can't reignite the fire under real estate and it looks like it doesn't want to." He suggests that a solid floor for iron ore at $100 in the short term might exist, but the longer-term outlook is less optimistic.


Name Peter Milios

Peter Milios is a recent graduate from the University of Technology - majoring in Finance and Accounting. Peter is currently working under equity research analyst Di Brookman for Corporate Connect Research.