China’s Unraveling Starts to Hit Home
China’s Unraveling Starts to Hit Home
‘So Steve, your fund is up 20% in the past 12 months. How do we invest in this Intelligent Investor Value Fund?’
Unfortunately, that bit didn’t make it into last night’s 7.30 Report. But we did get quite a good run in Stephen Long’s piece on the China boom. You can watch the online version here if you missed it.
China’s unsustainable infrastructure binge is starting to wane, with ample evidence of rising inventories, commodity stockpiles and mass overproduction. The iron ore price is down 25% in the past few months and more than 30% in the past year. Not that you hear that from the Australian broking community. I got an email this morning from a Perth-based broker (with a very long list of mining buy recommendations):
The mining service companies have generally performed well this reporting season with results coming in broadly in line with expectations and as a result the respective share prices rising. We expect HDX to follow this trend.
Did anybody really expect 2012 to be a bad year for mining services? I would expect 2013 to be quite healthy too – there’s enough work locked in to guarantee it. It’s 2014 that you’ve got a problem. Potentially a very big one.
A final point. I’m seeing a lot of bulls claiming $120 is the price floor for iron ore. That, apparently, is where the marginal producers stop producing (this FT Alphaville blog post contains a JP Morgan cost curve). There are two problems with this.
One, it assumes demand continues to grow at a moderate pace (the low cost producers continue to expand low cost output). Which also assume China builds just as many airports, roads, train lines and houses as it did last year. That’s a big assumption.
Two, it assumes the marginal producers stop producing as soon as it is economically rational to do so. That often doesn’t happen in Australia (witness the recent bail out of Australian steel producers). It’s even less likely in China, where jobs are far more important than profits. As the Chinese represent the majority of marginal iron-ore production, there is no guarantee that loss-making producers will halt production. In fact, I would say it is highly unlikely.
In short, the $120 floor is unlikely to be a floor at all.
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Comments
Nice work Steve fame at last!
You never know you might me the next Alan Kohler?
But seriously, good call on picking and then acting upon the unravelling of the China led mining boom.
Just a pity they could not have led with you +20% yearly return eh?
All the best
We've been calling for a China-unwinding for years now, and it seems to be underway (and public perception has also clearly shifted). One thing that seems out of place, though, is that the Aussie dollar hasn't cracked yet. I'd have thought that the $Adollar correction would also be occurring now, but every time the AUD sinks it slowly floats up again. I've got to say that the AUD strength has me a bit perplexed and is the main remaining question mark for me.
You are right Gareth - the relationship between commodities and the AUD has broken down (i.e. Dutch Disease seems less relevant now). my opinion is that it is no longer about pure demand and supply anymore - it is about demand, supply and government.
Stories of the Swiss and German central banks seeking to diversify their reserves into currencies like the AUD (along with record low 10 year bond rates and record high foreign ownership) are starting to stack up and make it very hard for Australia to compete. It seems that even if you are a 'free market' economy, when not everyone is playing by the same rules, you can get screwed.
The worry is that when the mining jobs go, what will be left? Australia is a high-cost operator in a low-cost environment.
Gareth
Do you think this is due to the ongoing demand for our resources? While export growth might well have slowed, actual exports are probably still pretty high, albeit at lower prices.
How much affect on currency demand does reduced capital investment have? Must have some but not sure how much relative to export demand.
Of course there is the interest rate overlay on top of all of this at the moment too
At the moment central bank demand is dwarfing everything else. A good friend of mine who trades the Aussie out of Hong Kong for HSBC tells me everything else is a drop in the ocean relative to central bank flows (particularly the PBOC). Worth a blog post I guess.
Interesting point Steve. Though I will say that when I worked on a bond desk in the mid to late 90s (lower AUD, no commodities boom), even then many or most of the biggest ticket trades were central bank/government bank flows, mostly out of Asia, and I was working in Sydney not Hong Kong. PBOC was the biggest name then, too. It would be interesting to get the perspective of a trader who's been around 20 years or so, if such a species still exists. Has your contact noticed a significant shift in recent years?
Good work Steve. I must say I feel quite comfortable at present with your long term investing thesis re: china, mining etc
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