In yesterday’s Money Morning I sounded the alarm on China.
Some of the data coming out from China right now, like bank lending, has just fallen off a cliff.
Between them, China’s big four banks have reportedly made ZERO new loans in the first half of May.
That’s a big deal because Chinese property developers need these bank loans to finance construction. According to Morgan Stanley, even large developers are waiting five months to get financing.
The smaller developers, if they can even get financing, are looking at an interest rate of 15-18%, probably from fringe-lenders.
At those rates they’d be better off putting it on a credit card!
Without a source of credit, developers are finding it very hard to build anything new, or even to finish projects off.
This is what the Chinese government wanted – to cool the property bubble down.
It looks like it is working a bit too well! And it could have a major impact on the Aussie economy…
With bank lending drying up, Chinese construction will soon STOP.
This has loads of follow-on effects.
For instance, the Chinese property market accounts for 40% of Chinese steel consumption.
So if Chinese property building grinds to a halt, there could up to a 40% drop in steel demand on the horizon. And that’s not even looking at the potential falls in steel demand for car production, infrastructure and the other industries that take the remaining 60%.
The Impact on Australian Iron Ore
This is where Australia comes in.
The Chinese steel industry is the biggest buyer of Australian iron ore, and it looks like demand for Australia’s most famous export (after Kylie) is about to fall in a hole.
The quotes from the Financial Times I used yesterday describing China’s economy have gone viral on the net. These suggested that major commodity trading houses are finding that Chinese commodity buyers have gone cold. And some big players have apparently defaulted on contracts in iron ore.
This is terrible news for anyone who is long on iron ore. You only have to look back to last September when it lost 35% in two months as a reminder of how volatile the price can be. This time around it has fallen by 12% in a month.
The fundamentals look pretty ropey. For the technical view of iron ore’s latest move, I spoke to our in-house technical guru, Murray Dawes of Slipstream Trader. He’s been making good money for his readers in this falling market, and reckons:
‘…Iron Ore prices are looking very sick indeed. $130 is the last line of support before a fall to $116. The impulsive decline from September to November last year (I.e. $181 down to $117) saw a perfect 50% retracement. The downtrend has now reasserted itself so I’d expect to see this $130 support fail in the short term and a sharp decline to $116. From there we can’t discount the possibility of a fall towards $100.’
Iron Ore – on its way to $110 / tonne?
This would have many institutional players howling, as so many of them are heavily invested in iron ore stocks. As a big player in Australia, It’s a bit hard not to be.
There is talk from big players that the Financial Times quotes about Chinese commodity buyers defaulting on contracts are ‘rumours’ designed to give traders the opportunity to short sell the iron ore market.
And I thought the gold bugs were supposed to be the conspiracy theorists!
What Happens Next For Iron Ore?
Well the next data we get on China will be Thursday lunchtime when the ‘Flash China Purchase Managers Index (PMI)’ is released. If it confirms all the recent news pointing at China stalling, then it could be an ugly day for iron ore, the rest of the resources sector, and the Australian dollar to boot.
Iron ore needs Chinese property construction, so the best hope iron ore has of a recovery is a stimulus program from China. I can’t see any hope of China’s property sector getting CPR from the government until next year, after the baton is passed from the current Chinese leadership to the next.
Iron ore is a commodity I’ve not tipped to Diggers and Drillers readers for a long time, because I prefer commodities that have supply squeezes and/or sustainable increases in demand. Iron ore didn’t fit the bill. Supply is on the up, and demand depended heavily on China.
Will Gold Face a Similar Fate to Iron Ore?
Gold fits the bill better, with supply that increases very slowly, and steadily rising demand.
But the latest developments in China may cast a shadow over gold too.
If China’s economy has dropped anchor – then will it keep importing gold in huge quantities?
In the last year, Chinese gold demand has become a big player in the market. It has imported an average of around 40 tonnes a month – around 18% of global gold mine output. These are just the official figures, and I’ll bet the real amount is far higher.
Will China keep importing if things are hitting the skids? My feeling is that most of the gold going into China is for China’s Central Bank – which should continue even if things slow down.
Some Chinese gold imports are for retail investors of course, and they are now buying around 0.25 grams per tonne per year. It’s possible this may actually increase if Chinese property investors decide to reallocate from property to gold. Other than the dodgy Chinese equity markets, they don’t have many other choices!
To be honest I’m not sure which way Chinese gold demand would turn in a slowdown. It’s something to think about, and we’ll have to watch the numbers for a while yet.
What’s in store in the meantime?
The reports I’m reading suggest the current leadership in China is brewing some stimulus up for this year.
However it won’t target property.
Rather it will point at the agricultural sector to reduce food price inflation, which has been a big problem.
If that’s the case, then in addition to hanging onto your gold…go short iron ore, and go long tractors!
Dr. Alex Cowie
Editor, Diggers & Drillers
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