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China’s appetite for steel is not over yet
https://www.ft.com/content/65cadd30-406b-11e7-9d56-25f963e998b2
Lower iron ore prices reflect fears for Chinese economy but bearishness is premature

11 HOURS AGO by: Alan Livsey
Cynics in Asia might say that the intensity of opinions on China is inversely proportional to the proximity of the pundit. Everyone is a China expert these days.

A case in point is iron ore. Given the country’s rapacious appetite for this key input for steel making, commodity analysts carefully monitor the movements of the rusty red metal ore. From afar there are some reasons for concern. China’s real estate market has had another boom period of soaring prices, which has raised concerns just when another round of government stimulus may have peaked. And note that base metal prices have gone all floppy since January. This suggests traders anticipate a downturn in the Chinese economy ahead. Domestic steel prices are off a sixth from December’s peak. Key input iron ore has had it worse, down a quarter.

But that bearishness looks premature. True, iron ore inventories at Chinese ports are high. These have doubled over the past year alone. Previous surges of stocks have eventually led to a price sell-off. At the last inventory peak in 2014, however, iron ore was over $100 per tonne. That not only squeezed steel mill margins but allowed domestic miners of low-quality ore to grab market share from high-quality producers such as Rio Tinto, BHP and Brazil’s Vale.

Iron ore closer to $60 makes that substitution more difficult. Moreover, steel demand in China not only remains reasonably robust but there are signs that government efforts to close inefficient mills has had some bite. Analysts at Jefferies note that prices for Chinese reinforced steel bars, which are used in construction, have soared partly due to reduced manufacturing capacity at a time of rebounding property prices. Demand for steel in China, half of the world market, has not died just yet.

Iron ore may well settle into a range between $50 and $60 for the rest of the year given such support. If so, shares of Rio Tinto, BHP and Vale likely have life left in them. All have dividend yields over 4 per cent and enough free cash flow to pay them. And BHP even has an activist, Elliott Management, demanding more money for investors.

From a distance, iron ore prices hint that steel demand will soon collapse. Given China’s history of unpredictable state intervention, such conclusions look premature.