One index of Chinese steel profits has plunged by almost 90 per cent this month.
Indeed, margins are so bad there are multiple reports that steel mills are now idling their blast furnaces and bringing forward planned maintenance to limit their losses, heaping downwards pressure on the iron ore price.
“The more you produce, the more you lose,” an international trader told Platts of the steel mills’ plight.
The tumble in the price – and further pressure on future prices, which are down almost 3 per cent – was likely compounded by China’s decision not to reduce official interest rates, despite the ugly economic slowdown it is facing.
But as Craig Botham, chief China economist at Pantheon Macroeconomics notes, China’s decision to keep policy rates on hold was logical given there is little evidence anyone wants to borrow.
“The problem … is that monetary policy at this point is pushing on a string. Rate cuts and liquidity injections only work if there is demand for credit, which is going unmet because it is currently too expensive or too scarce,” he says.
China is certainly not holding back on stimulus efforts, particularly in the areas that iron ore prices are most sensitive to.
Infrastructure investment project approvals have tripled in a bid to get this sector moving again. And in the property sector, which is estimated to account for about 40 per cent of iron ore demand, officials are madly trying to reverse the crackdown on indebted developers launched last year and get sales moving again.
Some 140 cities are said to have issued policies supporting property sales this year, including everything from easing home purchase restrictions and reducing down-payment ratios, to allowing interest-only repayment periods, to straight out home purchase subsidies.
But the results have been so far unimpressive. While house sales recorded their first month-on-month gains for the year in May, volumes were still 42 per cent lower than the prior year. New house prices recorded their ninth consecutive monthly fall in May, while sales of existing homes recorded their largest monthly drop since February 2015.
Patchy economic activity because of lockdowns and a lack of confidence in the pivotal property sector is not a recipe for demand or confidence.
Botham says as in previous property downturns, household deposits are rising, suggesting precautionary saving. Corporates aren’t too keen to borrow either because of slowing growth.
“Absent stronger domestic demand, they have little reason to borrow to invest, and most borrowing demand will be to meet short-term financing needs,” he says.
And embattled property developers would love to get their hands on funds, but they aren’t allowed to because the Three Red Lines rules, which impose restrictions on developer debt levels, are still in place.
How China escapes this slowdown remains to be seen. Ending the pandemic lockdowns will, of course, be important, but Botham argues fiscal policy needs to take over the heavy lifting.
“A successful fiscal stimulus would also boost aggregate demand and increase private sector credit demand, making monetary easing less futile than it currently would be,” he says.
But increasing demand for steel may take some time. And until then, steel mill margins and iron ore prices are likely to remain under pressure.
Of course, investors in BHP, Rio Tinto and Fortescue Metals Group need to keep this in context – even at current iron ore prices, the trio’s low cost bases mean they are making huge profits and still have the capacity to pay big dividends.
BHP’s cost guidance, for example, is between $US17.50 and $US18.50 a ton; in the context of a long-run iron ore price of about $US60 a ton, these are very strong margins.
Still, the miners have tumbled since late April, with BHP down almost 25 per cent, Rio down 15 per cent and FMG down about 20 per cent.
Until we know more about whether China’s stimulus promises are working, the market may be cautious on Australia’s resource giants.