After athletes have stopped competing for gold, silver and bronze at the Beijing Winter Olympics this month, the focus will once again turn to iron and copper as China grapples with a real estate and building slowdown.
This has cut demand for steel for two reasons: the major developers are simply completing fewer buildings, while local and provincial governments, which sell them land, have less cash to spend on infrastructure. The extent of the slowdown will be clearer in the coming weeks, after the lunar new year holiday period is over and data starts to roll in again.
Even prior to the new year, indications were of a general softening in economic activity. BMO Capital Markets analyst Colin Hamilton pointed to the average failure rate of 21 per cent for land auctions in January. This is a key part of local government revenue: margins for real estate heavyweights such as Evergrande have been constricted by the high cost of land.
“In our view, this data goes to the core of China’s present wider economic challenge,” Hamilton said. “With land sales weak, local government revenue is down and hence their capacity to push forward infrastructure projects to underpin economic growth is limited. We expect further, more aggressive measures relating to property market support over the coming weeks.”
He also pointed to local governments removing land from auction because of the price drop, resulting in a 43 per cent decrease in land being put up for sale.
The property sector plunged into crisis last year once Evergrande’s troubles became apparent. Others are also struggling, shown by property bonds plunging in value. This has hit Shimao Group and other companies that appeared in decent shape before September when the world’s attention turned to Evergrande as a possible Lehman Brothers-style scenario.
The question for investors (as everyone is exposed to China) is whether the government allowing the property sector to flounder is a sign of a changed approach from Xi.
The president has shifted his rhetoric to “common prosperity”, changing the ambition from constant 6-plus per cent gross domestic product (GDP) growth fuelled by major infrastructure spending to a more all-encompassing national goal of “development gains [benefiting] all our people in a more substantial and equitable way”, as Xi told the World Economic Forum last month.
Chetan Sehgal, lead portfolio manager at the Templeton Emerging Markets Investment Trust (TEM), said there was now an emphasis on “getting stability back” in China. He said the other side of the coin was the new approach to massive tech companies that continued to grow strongly during the pandemic.
Sehgal pointed to a greater focus on tax collection from companies such as Alibaba (US:BABA) and Tencent (HK:700) and their owners. “If there is a pressure somewhere on the government finances, then they do expect that the private entrepreneurs also do their bit for society [and hand over more tax],” he said.
The government also has its previous trick to go back to: heavy stimulus, as Hamilton has forecast.
Heavy metal
China’s economic health is important for London investors because of the heavy weighting ascribed to mining companies in the FTSE 100. Despite BHP’s (BHP) recent exit from the top index, Rio Tinto (RIO), Glencore (GLEN), Anglo American (AAL), Evraz (EVR), Antofagasta (ANTO) and Fresnillo (FRES) make up around a tenth of the index’s market capitalisation, and have an outsize impact in terms of dividends. Even Evraz, which largely sells to the Russian and US markets, is affected by changes to the iron ore price.
The price of the steel production often dips in winter as Chinese steelmakers slow operations, before getting moving again in March, although supply issues in Australia and Brazil have kept the price fairly strong in recent weeks, at around $140 (£104) a tonne.
Copper prices remain elevated, moving within a $9,500-$10,100-a-tonne range. This is where the risk lies, according to Hamilton. “It’s a struggle to justify today’s copper price on today’s copper fundamentals,” he said.
The long-term picture is still strong due to energy transition demand, but a shift downwards could mark a leaner period for miners now used to copper at such high levels. There are plenty of bulls around in regards to 2022 pricing, however.
“With a tailwind of fiscal and monetary easing from China driving a strong restocking cycle, we see positive demand drivers for iron ore and copper at a time when supply risks are rising,” said BlackRock Energy and Resources Income Trust (BERI) co-manager Mark Hume this week. Bernstein has also picked copper and iron ore as its favourite base and bulk metals of 2022.
Iron ore going back to its early 2021 level above $200 a tonne might be a stretch, however. Liberum analysts highlighted the risks to iron ore and steel from the combination of the common prosperity plan and real estate slowdown in a podcast this month. The basic idea is that common prosperity projects such as new schools and hospitals will require less steel than the thousands of apartment buildings pumped by Evergrande and others in the sector.
It will take some time for apartment buyers to pile back in to the market, meaning the demand outlook is similarly cloudy.
“Suppose Evergrande comes out with a new project, what are the chances somebody is going to say ‘yes I want to buy into that'?” asked Sehgal from Franklin Templeton.
There are levers the government can pull, though, he said: “Mortgages have been very restricted thus far, the rates are much higher than the rest of the world at 5.5 to 6 per cent… so there is some scope for relaxation.”
The government has already started down this path, cutting the benchmark lending rate for the first time in two years last month from 4.65 per cent to 4.6 per cent. As a direct buyer of Chinese companies, Sehgal said there was still plenty of opportunity in the Middle Kingdom.
“There will always be some sector and some place where China offers an opportunity,” he said, although added that it helps to “not be in the line of fire of the government”.
Any company that has had that experience would not disagree. Xi has proved time and time again he will do whatever it takes to reach his goals – be it hosting Winter Olympics in a region with little or no snow, or now common prosperity. London investors with an eye to earnings and dividends from the major miners will have to hope previous growth goals are not abandoned entirely.
