Its Over

....and that's why we have to avoid the resource sector.....at least for now.
Australia’s China problem is bigger than we think

Look past the renewed pressure on iron ore prices. China needs radical surgery that its leaders appear reluctant to deliver. A prolonged period of pain looks likely.
Sep 6, 2024 – 11.48am

Home owners protest in Shanghai over rumours of a new levy to maintain ageing properties. Volkswagen weighs the first factory closures in its history. OPEC pulls the handbrake on increases to oil production.
Three very different events from the past week. Three different parts of the world. And three more examples of why Australia has spent the week worrying about the wrong things.

Treasurer Jim Chalmers’ bizarre decision to put pressure on the Reserve Bank by suggesting high interest rates are smashing the economy, and RBA governor Michele Bullock’s assertion that inflation is the country’s greatest economic problem, seem to ignore a vital point.
The very commodity that has powered huge government spending in recent years and helped keep inflation high – iron ore – is now facing serious structural decline as China’s economic problems mount.
But more broadly, it’s becoming clear China probably faces a decades-long task of rebalancing its economy, a task that is likely to be made even more difficult by escalating geopolitical tensions. Australia’s chances of powering another era of prosperity on the dragon’s back look limited at best.

Iron ore futures are again testing $US90 a tonne, the lowest point since November 2022, after China’s main steel industry group advised mills to be cautious in lifting output too quickly, lest they snuff out the usual seasonal uplift in demand we see around September and October, before the northern winter.
“There will be a certain degree of recovery in steel demand through September and October, which is favourable for the steel market,” the China Iron & Steel Association said. “However, we need to be cautious of the impulse to restart production otherwise any improvement in the situation will end up a flash in a pan.”

It is effectively a repeat of last month’s warning from inside China that the steel industry faces a “long winter” because of overcapacity that has crunched the profitability of mills; a recent survey suggested just 1 per cent of China mills are profitable, a situation that won’t be resolved without serious production cuts.
Damage has been done

The three events mentioned above help tell the story of what’s going on.
While the popping of China’s property bubble – which accounts for between 25 per cent and 40 per cent of steel demand, depending on who you ask – is a well-known problem, it’s not just construction and sales of new homes weighing on sentiment.

Last week’s protests were sparked by online reports that a new government measure to help pay for maintenance on ageing properties built over the past three decades – many built rapidly, cheaply and poorly – would be funded by home owners.

The government moved to quash the rumours, declaring it would pay for the maintenance. But Duncan Wrigley, chief China economist at Pantheon Macroeconomics, says the damage is done.

“This issue is set to fester in the absence of an easy solution, and provides another reason for households to save more, rather than consume.”

High household savings and a lack of consumption are weighing heavily on China’s domestic economy, with another barrage of manufacturing, services and property sector activity indicators released this week showing no signs of improvement.
Relying on exports for growth

Growing concerns about weakening demand from China’s sputtering economy have hit commodity prices hard in recent months, from iron ore and copper to aluminium and oil. The decision by the OPEC+ nations on Thursday night to delay production did next to nothing to buoy oil prices, demonstrating just how heavily China growth worries are weighing on this market.

Leaving aside the fact no one really believes China’s 5 per cent growth target is achievable or even very real – Bank of America became the latest bank this week to slice its GDP forecast for 2024 from 5 per cent to 4.8 per cent, with its forecasts for 2025 and 2026 also cut to just 4.5 per cent – the domestic economic weakness means China must rely on investments and exports for growth.

As such, surging exports of steel products (about 100 million tonnes worth, according to ASX-listed Bluescope Steel, which has been hit hard by the subsequent collapse in profitability per tonne of steel) and manufactured goods such as electric vehicles are not a sign of economic strength, but of weakness.

And given the pain we’re seeing these surging exports are causing to competitors in Europe and the US – VW’s glum warnings of job cuts and the collapsing margins of Elon Musk are perfect examples – it’s likely China’s growth strategy will only ratchet up geopolitical tensions with the rest of the world.
Xi [Jinping] is showing no sign of delivering the sort of radical surgery the Chinese economy requires.
Hendrik du Toit, the founder and chief executive of the $250 billion asset manager Ninety One, jokes that Elon Musk is “probably going to end up in space rather than in EVs because the Chinese are going to outcompete him”.

For Australia, the key number to watch is the iron ore price, which has fallen from about $US145 a tonne at the start of the year to $US90 a tonne, a level at which many smaller miners are simply not profitable.

Tom Price, commodity analyst at Panmure Liberum, sees short-term pain heading into the seasonal winter lull for China’s steel mills, when they start paring iron ore purchases and output.

“After years of price-buoying disruptions, seaborne’s ore mining majors are finally delivering an unmitigated, record-high, collective flow of ore to their principal customer, China. Problem is, China’s need for ore – and the steel generated from it – is faltering,” he says.

It’s generally accepted that the $US100 a tonne mark is the level at which price support for iron ore kicks in. But it’s notable that Liberum’s forecasts have the price slumping to $US85 a tonne in 2025 and $US71 a tonne in 2026.

Macquarie Group strategy guru Viktor Shvets warns those predicting China is approaching the bottom of the cycle are likely to be disappointed for a long while to come. He believes five key fixes are required to get the Chinese economy back on track:

Comprehensively removing risk from the property sector, largely underwritten by the central government.

Transferring the large debts of local governments and state-owned enterprises to the central government.

Redesign China’s tax system to wean local governments off land taxes.

Agricultural reforms to improve productivity.

Lower savings rates by improving China’s universal basic income and strengthening social and healthcare safety nets.

But he fears Chinese policymakers will “not easily consent to such dramatic shifts, unless there is no other choice”, in part because these policies could weaken state control over the economy and society. “At the current juncture, China is riding on the coattails of investment, manufacturing and exports, allowing policymakers to come close to their targets, albeit at the expense of worsening long-term structural fault lines.”

Marko Papic, geopolitical guru of BCA Research, argues Chinese Premier Xi Jinping has shown in the past he has little interest in stimulating the economy if it means adding to debt levels; in 2018, when China was hit with Trump tariffs, Xi doubled down on reducing leverage in the economy. “Xi Jinping truly is a member of the Tea Party. He’s an Austrian economist. So he really, really does not like the leverage that’s built up in the system.”

Shvets and Papic are making the same, vital point: Xi is showing no sign of delivering the sort of radical surgery the Chinese economy requires. Papic thinks the next US government will be intent on dodging a trade war with China, but he says that for the iron ore price, and the Australian economy, it’s the domestic economy that matters.

And there are simply no quick fixes there.