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Peak China

Peak China is something investors in the Australian market will have to start considering, especially in the resources sector. That’s not me speaking but the Reserve Bank.

It won’t happen immediately - but about now is when investors can expect outsized returns from selling commodities to China to peak.

Several times in the past couple of years we have been given hints of that peak arriving as Chinese authorities have slowed, and then boosted the economy driving iron ore and coal prices higher, lower, higher and lately, lower.

The Chinese government have used measures including stimulatory spending increases, reductions, changing the rules of work for mining companies, cutting capacity in steel and coal, and currently to ordering shutdowns to limit production around Beijing in the approaching winter season (and in time for the 19th National Congress that will elect a new five year leader and leadership team).

These measures have directly influenced global coal and iron ore prices - as we saw last year and again this year. Now the production cuts have been ordered in and around Beijing) 50% according to some reports, for steel companies in the north of the country and especially in Hebei province which is next door to the capital and a major source of pollution and the terrible smogs of late autumn and winter.

So iron ore prices have slumped - down 14% in two and a bit weeks and 4.1% on Tuesday to $US66.09 a tonne on Thursday, according to Metal Bulletin. The price is down more than 10% so far this week and close to 18% in the past month.

This week’s minutes of the Reserve Bank board meeting reveals that China’s economy and outlook was the subject of the monthly special briefing the bank’s management organised for the board (a couple of months ago it was on ’neutral real interest rates’ which saw a lot of silly talk about looming interest rate rises.

China and its changing economic drivers are developments clear to the forefront of RBA thinking.

In a speech in Perth on Thursday, RBA Governor, Phil Lowe said (https://www.rba.gov.au/speeches/2017/sp-gov-2017-09-21.html) said in a speech entitled “The Next Chapter” (for the Australian economy)..

“While growth in China is trending lower, the share of global output produced in China will continue to rise, as per capita incomes converge towards those in the more advanced economies.

“As this convergence takes place, the structure of the Chinese economy will change and so too will China's economic relationship with Australia.

"Exports of resources will continue to be an important part of that relationship, but increasingly trade in services and other high valued-added activities, including food, will become more important. Notwithstanding this, there are risks on the horizon, with the Chinese economy going through some difficult adjustments.

"One of these is the switch from a growth model based on industrial expansion to one based more on services. Another is managing an increasingly large and complex financial system. Australia has a strong interest in China successfully managing these challenges.”

That echoes comments he made to a Brisbane dinner the night of the September board meeting in the Queensland capital:

"One focus was on the difficult trade-off facing the Chinese authorities. There is a clear need to, and a desire by the authorities to, address the high and rising levels of debt in China. At the same time, though, the authorities are committed to achieving growth targets that are still quite high. It remains an open question as to whether both of these objectives can be achieved. Here in Australia, we have a strong interest in the right balance being achieved.”

And the minutes of that meeting, released this week revealed more

"In China, GDP growth had been a little stronger than expected over the first half of 2017, supported by generally accommodative policy settings. Strong growth in infrastructure investment had continued in July, and further sharp increases in crude steel production and electricity generation had continued to support imports of coal and iron ore from Australia. In the rest of east Asia, a pick-up in export growth as global demand strengthened had underpinned stronger domestic demand.”

"Members discussed the influence of China on the global iron ore and steel markets more generally. They noted that China was by far the largest consumer and importer of iron ore globally. This reflected the fact that China, with the world’s largest population, had reached a similar level of steel production per capita to that of industrialised economies.

"Iron ore prices had been supported at higher levels because of sustained strong demand for steel in China. However, prices were expected to fall in the period ahead because of the ongoing expansion of global iron ore supply following an extended period of strong investment. Members also noted that Chinese steel production per capita was likely to be close to its peak and that growth in Chinese steel production would not add much to global demand for iron ore in the future.

“Members observed that, in the longer run, there was potential for India to have a noticeable effect on commodity markets as investment in residential construction and transport infrastructure increased.” India remains ‘potential’ and nothing more.

And there it is peak China in the words “prices were expected to fall in the period ahead because of the ongoing expansion of global iron ore supply following an extended period of strong investment. Members also noted that Chinese steel production per capita was likely to be close to its peak and that growth in Chinese steel production would not add much to global demand for iron ore in the future.”

So for all the money that BHP and Rio Tinto are spending in the Pilbara on new capacity and talk of other projects. the only way for prices is down - $US70 a tonne might be the optimum. Coal prices as well face constraints from the recently introduced ‘restraints’ on imports as the nervous centra government tries to soften the blow on the politically sensitive and depressed coal mining provinces of the north and northeast.

The RBA is seeing the start of a new trade relationship with China (and many other of our big Asian commodity markets). Investors had better take heed.

View More Articles By Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

At the AFR he was a finance writer, Finance Editor, News Editor and Chief of Staff. At the Nine Network he was supervising producer of Business Sunday for more than 16 years. He has also written for other online and analogue print publications here and overseas.



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