Now, unlike events on Wall Street and especially in the tech heavy Nasdaq market, this news from China is a reason to be concerned about valuations in the local market, especially, valuations of iron ore companies such as Fortescue (FMG), and to a lesser extent, the price of BHP Billiton (BHP) shares.
There are media reports from China that the Chinese government is planning a crackdown on the way the country’s steel mills and others finance their purchases of imports of iron ore from countries such as Australia and Brazil.
It certainly shook our market yesterday – a modest rise at the start turned into a fall of almost 1% by the close of trading.
The share prices of Rio Tinto (RIO) and Fortescue Metals all took a pounding because they are more exposed to iron ore pricing. Rio shares fell 1.2% to $61.30 and Fortescue shares fell 2.3% to $5.
By contrast, BHP shares only fell 0.7% to $37.61 because it has a suite of other minerals (coal, copper, silver, lead and aluminium) to offset any iron ore weakness (which is the company’s profit centre though).
But judging by the market moves offshore overnight, and the rise in the value of the Aussie dollar back to close to 94 US cents, the impact of the news from China will prove fleeting – at least until the next big move in the iron ore price.
The move by the Chinese authorities is said to be an attempt by the central government to close inefficient and heavy polluting mills (said to cluster in Shanxi, Hebei and Jiangsu provinces).
China’s Banking Regulatory Commission warned banks to tighten controls over letters of credit for iron ore imports in a document that caused iron ore futures in China to drop 5% to around $US108 a tonne, compared with the most recent high of $US119 a tonne several weeks ago.
Rumours of the crackdown, which are expected after the May 1 holiday tomorrow, have been circulating in China for a couple of months, and helped trigger the slide in prices in late February when a panicked sale of one order of ore saw a 9% fall in a day.
Steel mills and traders have used iron ore imports to raise money as other sources of credit dry up in yet another channel for off-book or “shadow” financing. Part of the attraction of the practice is that mills benefit from lower international interest rates compared to those in China. Copper, gold zinc and lead have been used in similar ‘shadow’ financing methods in the past couple of years.
These ‘shadow’ channels for financing have helped raise money from non-banking sources for re-lending to the real estate sector which has been starved of new money because of capital controls designed to shut off the flow of speculative funds into the sector.
The Financial Times reported overnight that while a useful tool for raising money, iron ore has proven to be bulky and costly to store and transport, which has limited its use and flexibility for a financing tool for weak real estate companies and their shadow banking friends. It doesn’t compare to copper or gold, for example, in ease of storage and transporting and use as security for loans.
Iron ore stocks at Chinese ports are at 109.55 million tonnes, according to estimates over the weekend. While high in absolute terms, it is still relatively low in terms of the size of the industry’s import demand which could total close to 850 million tonnes by the end of December.
First-quarter iron ore imports surged 19.4% to 222 million tonnes from the same period of last year.
That was in response to a 2.2% rise in production to 202.7 million tonnes in the quarter. That means China could produce more than 820 million tonnes of steel this year – which would be yet another record and up on 2013’s 779 million tonnes (up 7.5%).
China’s iron ore imports jumped 21% to 73.96 million tonnes last month, from 61.24 million tonnes in February which were cut by the Lunar New Year holiday. March’s imports were almost 15% above the level for March 2013. Shipments hit a record high of 86.82 million tonnes in January, as steelmakers built stocks ahead of the Lunar New Year shutdown.
Those figures go some way to explaining the strong quarterly performance of the iron ore operations of BHP, Rio and Fortescue.
But there was a reason for this strong import demand – local iron ore production is falling, and much of it is low grade ore which costs more when the yield of steel from each tonne of ore is compared.
The media reports suggest that Chinese regulators are increasingly concerned that a heavily indebted mill could collapse, triggering the collapse of local banks and others who have helped finance its iron ore imports. This in turn could damage local government, employment and tax revenues, raising the prospect of a contagion like effect spread from parts of the country where the iron ore business is weak and under pressure, such as in Hebei and Shanxi provinces.
Haixin Steel (AKA Highsee Group) has already defaulted on a debt and the local government is reportedly trying to save it from collapse. A collapse could trigger problems for banks and other financiers in the province.
But there is another positive factor at work for iron ore imports and that’s the falling production and grades of Chinese domestic iron ore output.
Reuters reported earlier this month that "China’s bid to slash its dependence on foreign iron-ore miners by creating its own mega producers risks running aground before it starts due to high costs and poor quality of ore. Instead, overseas suppliers may end up shipping more to their top market.
"For two decades, China has been trying to reduce its reliance on iron ore supplied by top producers Vale, Rio Tinto and BHP Billiton without much success because the price of the ore it produces is higher. These global miners are boosting output to capture more of the Chinese market through massive expansion schemes to increase their dominance.
"In an effort to make its own iron-ore mining more efficient, China, which buys more than two thirds of the world’s iron ore, is drafting a plan to create six to eight domestic iron-ore miners by 2025, each with an annual capacity of more than 30-million tonnes, state news agency Xinhua has reported.
"Beijing wants Anshan Iron & Steel Group, a steelmaker with its own iron-ore mines, and the Metallurgical Mines’ Association of China (MMAC) to lead the plan. A draft is expected by the end of the year and will be submitted to the State Council for approval.
"However, combined production would at best amount to only a third of total demand, making a target to cut imports to below half of China’s requirement within 10 years look impossible and suggests big global miners may have to ship even more.
"While Chinese iron-ore production continues to grow every year, the low quality of the ore is forcing miners to dig deeper and bloating costs even more."
Now that won’t have an impact now if the crackdown on the letters of credit and other financing methods trigger a slide in import demand by small, weak steel mills.
But it is a bullish point in the medium term.
And watch India. The country is groping its way back to sorting out its domestic and export iron ore production and claims to be aiming at shipping 20 to 25 million tonnes of iron ore over the next year.
