Can China help bail out the global economy? (October 20, 2008)

If you think China’s super-hot economy and the astounding growth rates it has posted over the last decade will help buffet the rest of the world from the economic meltdown, you might want to think again.

China is not immune to this crisis and proof is no further than the website of Mount Gibson Iron (MTGRF-O, MGX-a), an Australian iron ore producer.

In an Oct. 9 letter to the Australian Stock Exchange, Mount Gibson’s managing director, Luke Tonkin, said the company had received requests from a number of customers in China to delay hematite ore shipments scheduled for the second quarter of the financial year.

“Customer and iron ore sector analysis indicates a slowdown in demand for iron ore in China due to current economic uncertainty and the tightening of credit facilities, leading to reductions in steel production and the current significant buildup of iron ore stockpiles at Chinese ports,” Tonkin wrote.

Alexander Hacking, an analyst at Citi Investment Research, noted in an Oct. 9 industry iron ore industry report that Chinese steel mills have been cancelling expensive contracts to buy Indian ore, while spot prices for iron ore fines have dropped to US$11 per tonne in October, the lowest levels since the middle of 2007. He also wrote that in August, China posted its first monthly decline in pig iron production in eight years. In the past two months, China’s domestic iron ore production has fallen by 20 million tonnes.

Meanwhile, freight rates continue to plunge. Current spot shipping rates are estimated at US$45 per tonne for Brazil-China, US$16 per tonne for West Australia-China, and US$23 per tonne for Brazil-Rotterdam. These are down 60% from peak levels, Hacking reported.

According to Dow Jones Newswires, the Baltic Dry Bulk Index — which measures shipping rates for dry bulk carriers on 40 different routes — fell on Oct. 9 to its lowest level in 28 months on worries of a recession in the West and expansive iron ore inventories in China.

“I don’t know what Canadian mining companies are telling you, but demand has really collapsed in China and India,” says a seasoned Singapore-based journalist who has covered Asian business for more than two decades.

The journalist, who requested anonymity, noted that last year China’s gross domestic product growth came in at a sizzling 12%. But that rate is expected to fall to 9% this year when revised numbers come out in February.

“There is no shortage of economists predicting seven to eight per cent growth in China next year,” he points out. “That’s a helluva comedown from twelve per cent. And India is even worse.”

Recent reports from Citi Investment Research, a division of Citigroup Global Markets, don’t seem to offset the prevailing gloom.

In a research note to clients on Oct. 9, analysts Thomas Wrigglesworth and Catherine Wang forecast a sharp drop in coal consumption growth to just 2.8% for 2009, down from 10.9% in 2008. “We continue to think that energy consumption will be positive in the long term, but a cooling period looks very real,” they warned.

The analysts forecast a 5% increase rather than their previous 10% increase in 2009 contracts and see spot prices plunging 30% quarter-on-quarter in the fourth quarter of this year.

Next year, they anticipate a 4% year-on-year decline in spot prices for coal, a 15% drop from their previous estimate. For 2010, they are lowering their estimate on prices by 24%.

One worrying sign they point to is inventory that has grown by 50% since June 2008 at Qinhuangdao, the chief sea port in Hebei province, 300 km east of Beijing. Inventories there have reached 8.7 million tonnes, 55% above the average since 2005. The port’s total capacity is 10 million tonnes.

For all Chinese ports, iron ore inventories amounted to 70 million tonnes, according to Citi, noting that “normal stocks” are around 30 million tonnes. The additional 40 million tonnes in stock represents about three weeks’ consumption.

Citi is also forecasting that the industrial component of coal demand will contract 5% next year as steel producers shut capacity.

One factor is that China’s steel mills are cutting demand for iron ore because economies elsewhere are slowing and want fewer Chinese goods.

According to Hacking of Citi, Shougang Steel, Angang Steel, Shandgong Iron and Steel and Hebei Iron and Steel, four large state-owned steelmakers in northern China, have agreed to cut production by 10-20%. Together, the four firms are responsible for about 20% of China’s total steelmaking capacity.

Crude steel production growth in China slowed to 2.4% year-on-year in August, down from 8.8% in July. No doubt part of the slowdown was a result of the hiatus during the Olympic Games, but no one knows to what extent the Games curtailed steel production in the rest of the country. Citi is forecasting that Chinese crude steel production growth will grow 8% in 2009 and 18% in 2010, down from the five-year trend of 22% growth.

In a Sept. 29 report, also from Citi Investment Research, analysts Alan Heap and Alex Tonks said that they did not expect a huge fiscal stimulus in China with an emphasis on infrastructure.

“The domestic economy is slowing and the infrastructure build-out will continue,” they noted. “Indeed, in the fourth quarter earthquake repairs and a resumption in projects will see a re-acceleration of activity, but it will not be boosted by a major skew in government policy towards growth and fixed-asset investment as we previously expected.”

They note that housing accounts for about 20% of China’s fixed-asset investment (FAI) and more than 20% of China’s total banking credit. They predict that FAI in the year to date of 27% will likely slow to 20% next year if the residential housing market slows.

Demand for other commodities in China may also ease next year. Citi notes that aluminum production in China has increased 12.3% so far this year, versus its previous forecast of 19%. And while underlying demand for copper in China “remains robust,” Citi notes, “large inventory swings cloud the picture.”

“Shipment of copper semi-manufactured products continue at a robust twenty per cent per year, but double counting and other problems make this data difficult to interpret,” the report states. “Anecdotal comments from fabricators indicate that domestic demand remains quite buoyant although export orders continue to fall, demand for air conditioners is slowing, reducing demand for tube.”