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Chinese Economic Outlook "Skewed Heavily To The Downside," BNP Says
Over the past several months we’ve built on several narratives out of China certainly not the least of which is the idea that economic growth in the country is decelerating quickly at a time when accelerating capital outflows make devaluation an unpalatable (if inevitable) proposition. Signs of a dramatic slowdown were on full display earlier this month when GDP growth slipped to 7%, the slowest pace in six years, while key indicators such as rail freight volume have fallen completely off a cliff:
With the country’s tough transition to a service-based economy being made all the more difficult by the hit industrial production will likely take as Beijing ramps up efforts to fight a pollution problem that was thrust back into the spotlight early last month thanks to a viral documentary, it’s reasonable to suspect we’ll be seeing a lot more of the idle cranes, empty construction sites, and half-finished abandoned buildings that greeted Bloomberg metals analyst Kenneth Hoffman who returned from a tour of the country earlier this month. Ultimately, Hoffman’s assessment was that metals demand in China is collapsing and isn’t likely to pick back up for the foreseeable future.
This is bad news for the Chinese economic machine and it’s also bad news for any iron ore miner out there whose marginal costs aren’t low enough to stay profitable in the face of a protracted downturn in prices because if you can’t convince the big guys that your price collusion idea will pass regulatory muster, well, they’ll likely take the opportunity to keep right on producing despite the slump and run you out of business. With the stage thus set, we bring you the following from BNP who explains why iron ore prices aren’t likely to rebound any time soon, and why the economic outlook for China is indeed “as bad as the data looks, if not worse” (to quote Mr. Hoffman).
Via BNP:
Global commodity prices have fallen sharply since last summer, dragged down by a cocktail of fading Chinese industrial demand, surging supply and a strong USD. Oil has inevitably garnered the majority of headlines but iron ore prices have fallen even further. Iron ore prices have collapsed by close to 50% since last July and over 65% since the beginning of 2014. Falls have accelerated in recent weeks, almost becoming a rout, with prices down over 30% year-to-date.
The analogue of China’s unprecedented construction bonanza has been extraordinary levels of both cement and steel production and consumption. We have documented the epic nature of the former with China incredibly producing more than twice as much cement in the last five years than the United States managed in the previous century (China: Cementing The Bear Case).
The increases in China’s steel production and consumption post-GFC have been almost as, but inevitably not quite, so spectacular. Since the end of 2007, China’s steel production has leapt by over 300 million tonnes while production in the rest of the world has slightly slipped. As will be discussed below, China’s steel production has started to flatten out over the last 12-15 months but, at around 810 million tons over the last year, China’s steel production has now accounted for 50% of total global production..
The surge in Chinese steel production has inevitably required a counterpart in much higher rates of global iron ore production. China’s own, typically low grade iron ore production, has not been able to keep pace with demand growth, meaning huge increases in demand for iron ore from the rest of the world. This demand has been fed largely by huge increases in Australian supply and, to a lesser extent, Brazil...
The collapse in iron ore prices over the last 15 months or so reflects the interplay of a levelling off in Chinese demand in 2014 for the first time since the GFC and, given the inevitably long lags between investment decision and output, continued strong gains in global supply. Our calculations suggest that China’s apparent steel use grew by less than 3% in 2014; slower than even 2008’s 4% growth (Chart 5). The latest industrial production data suggest that downward pressure has intensified in the final months of 2014 and early 2015 with crude steel production down -1.5% y/y on average in January and February.
On the supply side, optimistic assumptions over the potential for Chinese steel demand growth to continue strongly for the rest of the decade has led to steady increases in productive capacity which are forecast to come on line in the next few years. Australian iron ore production alone is expected to increase by a further 196 million tonnes between 2014 and 2018….
Even as the risks for global iron ore supply are strongly tilted to the upside for the time being, the outlook for Chinese demand, in contrast to optimistic forecasts of producers, is skewed heavily to the downside. The key downside risk is of course the prospect of a multi-year and deep correction in real estate investment. Given the epic nature of the ‘stock’ and ‘flow’ adjustment that China’s real estate market faces, the best case scenario is probably that real estate investment (c.151?2% of GDP), bolstered by considerable policy support, could achieve a soft landing with zero growth over the next 2-3 years…
The worst case is that increasingly entrenched deflationary dynamics and the unprecedented weight of excess supply (the value of unfinished real estate projects at market prices reached a mind-boggling 75% of GDP in 2014) mean the real estate sector is relatively impervious to stimulus and real estate investment likely to fall sharply for several years.
Another critical dimension is China’s increasingly unsustainable levels of air pollution which is generating mounting political pressure for sharp reductions in steel, cement and, of course, coal output. As with the real estate sector, the best that can be said is that China’s pollution problem has perhaps stopped getting worse over the last year. The tough decisions and the real economic pain continue to lie ahead, however, with some estimates finding that China’s industrial production might need to fall by as much as 40% to meet global pollution standards.
As a reminder, here’s the graphic on the relationship between industrial production and efforts to remedy the country’s pollution problem:
China’s domestic steel prices have fallen to near record discount of c.25% vs. global prices. Meanwhile, China’s steel exports have soared by over 40 million tonnes over the last year; easily the biggest annual gain on record with growth of nearly 60%...
Chinese producers have been able to slash steel export prices (which appear to follow domestic prices with a lag of about five months) as the collapse in iron ore prices is (temporarily) boosting margins…
As already emphasized, there appears to be little to interrupt these strongly deflationary dynamics any time soon. With the large iron ore producers likely to keep increasing supply until prices fall to close to their estimated marginal cost of $35 per tonne, further falls in iron prices look inevitable. China’s continuing real estate correction and anti-pollution drive will continue to weigh on domestic demand although sharp reductions in domestic output ultimately required are likely to continue to be resisted in the short term by the authorities given their high cost in terms of output and employment. Domestic steel prices should fall sharply while China’s steel exports look set to continue soaring, procuring further strong downward pressure on global prices…
And that, ladies and gentlemen, is the decisively precarious situation that Beijing finds itself in as China attempts to project its economic and military prowess to the rest of the world. Call it the growing pains of a rising superpower, but don't call it an enviable position and don't be surprised to discover that contrary to what the Ministry of Finance steadfastly proclaims, there may indeed be such a thing as Chinese QE.
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"Call it the growing pains of a rising superpower..."
China is never going to be a superpower with its current economic model. China is a tool of the oligarchs, because its leaders were made massively wealthy pandering (no pun intended) to them. The US retains superpower status only because it holds on to the vestiges of a middle class. Being an industrial power isn't good enough to rule the world as established by Japan and Germany in WWII. Too bad the few hundred assholes who own 50% of the world's wealth (and the PNAC types who serve them) don't care about such things as national boundaries and what makes an economy work for the average guy. But Kings and Queens and their jesters never did care about such things.
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But they have lots and lots of gold.
and lots of copper, and lots of iron, and lots of oil, and lots of other things that are depreciating rapidly. Hopefully they have been holding on to their Treasuries as they are the only things they have that are going up in value.
You forgot the /sarc.
I forgot that a long time ago.
Metals out of the ground are worth alot more than in the ground IMO.
Demand may not change quickly, but now that Chicago CME is being revved up by New York help, the future is rosie./s
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You forgrt to mention our real estate market in Sydney & Melbourne. Bubbling away nicely.
Australia must be more than a little worried
You would think so. But no. As far as I can tell we are having just a dandy fiddle playing time while the rest of the world burns.
There will never be any problems here. NEVER! /sarc
But for those of us whom are a little more attentive it is not hard to see the cracks appearing in facade.
Increasing news articles with 'X hundred to be laid off at Y company' and housing prices in regional and smaller cities either flat or slightly falling.
Last time I checked, the Aussies were still in the Southern Hemisphere. Can you guys see that Planet X yet??
Everything's just fine thanks, here in Aussie land. Joe Hocky & Co told me so.
I think you antipodes remain a little closer to your roots.
Up here everything seems to have been ripped out and replaced with Skittles trees.
No happy ending for you!
For those who still believe that China is ruled by communists that should be last wake up call.
For last at least two decades China behaves of fascist state in every meaning of the word. Working people and any organizations that would truly protect interests of workers are being destroyed. Ordinary people benefit nothing from the whole western instigated and financed by robbing western middle class, economic boom of China.
Before Chinese worker was making a dollar a month and paid one cent for bread. Now Chinese worker was making 100 dollars a month and pay one dollar for bread calling that improvement.
Remaining true communists are killed, in prisons or gagged. What we have is fascist state of fused state and private corporations and government via rampant cronyism with intimate ties to the western elites, themselves cultivating fascism, global fascism.
China is part of global political system run by world elites through central banking, united in quest form debauchery, gluttony, and psychotic drive to ultimate extermination of ordinary people.
The multiple decisions of China to follow western prescription only to maintain illusion of functioning world economy with ghost cities, millions un-bought cars hidden from view, ecological catastrophe and spread of poverty in China are clear evidences of harmony at top echelons of global elite, despite often personality conflicts misconstrued as political antagonisms.
Now China’s central bank embarked on a version of QE to keep badly collapsed or deteriorated “good things” going joining US, Europe and Japan on the road to collapse. Within next 15 years or less China’s middle class 150 millions will join the rest of the western world middle classes in extermination camp.
ZH crowd and others wonder how long it will last before this illusion implodes since it cannot continue forever. They are waiting for spectacular and quick blast and immediate ruins of the system. I say look around, it is happening now. It is explosion in slow motion that hits weak and vulnerable first and then proceeds to the strong and resilient. We have to open our wide shuteyes to see. The world is not gonna burn. It is burning.
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China's problem is that commodities aren't worth crap and the globally, trade is a down right depression.
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WTF is going on at Walmart? “There Are No Stores in Denver Metro Open Past Midnight” – Employees
The U.S. is now more of a communist country than China is.
We just don't admit it.