China PMI buoys prospects

Investors in natural resources stocks can take heart from the performance of China's manufacturing sector over the closing months of 2012. Official data showed that activity expanded in December for a third consecutive month, lending weight to the view that - following a prolonged downturn - the world's second largest economy actually bottomed out during the third quarter. According to China's National Bureau of Statistics, the official purchasing managers' index (PMI) stood at 50.6 in December, unchanged from the previous month. (A measure above 50 points to expansion.)

Although the accuracy of China's state economic statistics has occasionally been brought into question, the positive trend reflected in the official figures was even more pronounced in the parallel PMI measure published by HSBC , which accelerated at its fastest rate since the early part of 2011. The PMI also showed that exports continued to falter over the final quarter, indicating that the resurgence in Chinese manufacturing is primarily due to a rise in domestic demand, rather than any marked turnaround in China's principal export markets in the US and Europe.

The figures would have pleased officials in Beijing, particularly as central government has been trying to reduce China's dependence on export markets; a vital objective given the relentless rise in the country's labour costs. There is also evidence to suggest that activity is beginning to pick up in residential construction after a lull brought about by measures that were introduced to deter speculative investment in property.

This is potentially good news for iron ore prices, which slumped to a three-year low of $90 (£56) a tonne in September, forcing some big producers like BHP Billiton to shelve, or even cancel, expansion plans. Though producers remain circumspect, the fact that prices have since recovered to around $145 a tonne has obviously prompted a re-think in certain quarters; Australia's Fortescue Minerals, for instance, has just reactivated the $1.1bn expansion of its Kings iron ore deposit. Analysts at UBS predict that prices will average around $100 a tonne over the next three years, helped in part by $156bn in infrastructure projects Beijing commissioned in September. Though China's new leaders are unlikely to initiate stimulus measures on the scale of the post-Lehman blow-out, continued urbanisation should bolster steel markets over the long-term. Last year, Australia's Reserve Bank predicted that steel demand for China's residential construction sector will not peak till around 2024 as ever more country folk opt for a high-rise existence in China's cities.

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