Is it Possible China’s Steel Industry Has Excess Productive Capacity?

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Today’s Daily Reckoning will be mercifully brief as your editor has a plane to catch and a newsletter to publish this afternoon. Fortunately, virtually nothing of significance happened overnight that requires analysis, at least nothing that we’re aware of. It was more of the same in commodity markets, with copper and oil going higher as the U.S. dollar slinks lower.

By the way, what has happened to Stern Hu? He’s disappeared from the front pages of Aussie papers. As far as we know, he’s still being held in jail without charge. Do you reckon the writ of habeas corpus exists in the Chinese legal system?

Speaking of jails and steel, BHP says Chinese iron ore imports are recovering and spot iron ore prices are up 38% year-to-date because of the resurgence in Chinese demand. China’s Ministry of Transport says iron ore imports to major Chinese ports were up 35% in July from a year earlier. That’s a lot of steel.

But is it too much?

Is it possible China’s steel industry – which is hovering up so much Aussie iron ore – has excess productive capacity? Would demand for iron ore be lower if the Chinese steel industry were more efficient? And what effect would that have on the Aussie ore industry?

We’ll answer some of those questions in a moment. But first this from the 21st Century Business Herald, “Mr Xu Lejiang Baosteel chairman also confessed the existing of both structural and periodical overcapacity in China’s steel sector. The former refers to the heavy polluting and energy-intensive capacity like construction steel, and must be weeded out. He said that while the latter points to those redundantly advanced capacities that cannot find sufficient demand like ship plate.”

“China’s steel output has taken up 48% of the world’s total in the H1 of this year, further exacerbates the oversupply picture and hurts the healthy industrial development. And Mr Roland Verstappen vice president of ArcelorMittal also said steel overcapacity is quite clear in China and which will press down steel prices, sweep smaller mills out of the market and causes unemployment.”

Full employment is a political objective in China, and probably dictates a fair bit of economic policy making. But if Roland Verstappen and Xu Lejiang are correct and China has too much steel capacity, we reckon it’s something Aussie ore juniors (and their investors) should keep in mind. Of course for there to be a contraction in Chinese steel production, there’d have to be a policy shift…or the entire Chinese economy would have to contract/implode for a period after the popping of its own credit bubble.

But let us leave aside the bubble fall out in China for another day. Let’s get back to Australia. BHP and Rio are larger suppliers to major steel makers. They’d be fine even if Chinese demand fell for a while. But the smaller ore outfits who have made supply deals with smaller mills…they might have a rougher time of it.

By the way, we don’t have time to get into it in detail today, but yesterday we said to keep your eye out for tangible assets at good valuations. By that, we were referring to companies with net current assets at or in excess of their market capitalisation. It’s more complicated than that. But we’ll have to expand on it next week.

Some reader mail?

–Hi,

If my memory is correct – at the beginning of the GFC most/all of the “four pillars” took back on to their balance sheets their “special purpose/investment” vehicles. I certainly recall a statement made by CBA. If that is correct the assets in those vehicles might contain some very problematic loans. Would any of your readers be able to confirm my recollection?

Kind regards,

Peter H.

Good questions. Answers can be sent to dr@dailyreckoning.com.au

–Dear Dan,

I read your daily articles with avid interest. The problem I have is that I appear to one of the few on the streets that agree with what you are reporting, and that is, that there are more storms ahead that we are sailing into. I feel like a later day Noah suffering scorn for my opinions to the point.

I have now largely shut up. The media are doing such a great job of shaping people’s perceptions (that the worst is behind us) that I am starting to feel paranoid doubting my own thoughts and publications like your own, a very scary thought. Which pill do you take the red one or the blue one? (The Matrix)

Noah (Brisbane)

This morning it was the orange pill. And it was called Ibuprofen. The best way to deal with the garbage in the newspapers is not to read them. But the best defence against misinformation is your own education and knowledge. Keep building your ark.

–Dan,

Isn’t it optimistic to suggest there has been a significant change in attitude, especially when the media and government boasts about an ‘end to the recession’ and the stock market keeps rising. People’s spending may have changed not because of any intrinsic shift in attitude but rather because of an extrinsic need to survive, and besides many perceive it as a temporary change.

Further to previous e-letters regarding the misuse of bailout monies given by the American government, an argument exists for just how naive even the most intelligent person is when it comes to even recognising the capacity for individuals to suddenly change attitudes. Let’s use the overused phrase ‘unintended consequences’ for such sheer stupidity.

Institutions (like Goldman Sacks) [sic] go to the Federal Reserve and the president for bailout money but before they receive this money those same people ask oh and by the way if you want us to really survive just let us become a bank (so that we can then multiply that money tenfold under the fractional lending system).

So these honourable men, who dearly want to save the financial system (whose actions of the past ten or more years were the cause of the crisis in the first place) take these billions of dollars of taxpayer monies and promise the government, the people and congress that suddenly they are going to be ‘good’ citizens. Surprise, surprise they choose: not to shore up their books; not to lend this money to good businesses who are the real lifeblood of an economy; but instead to drive up asset prices again via the stock market (and other risky ventures) and then to take half of all those false and unsustainable profits to pay themselves a hefty bonus (again surprise, surprise).

So whilst taxpayers are busy fending off the ravages of deflation and extreme debt a select few have inflated assets (temporarily) for a massive profit. Sadly the media see these profits as good and gleefully describe them as ‘green shoots’. Sadly, it seems the public have swallowed this garbage hook line and sinker.

I guess a change in attitude may come again but only when the economy falls again (and that can’t be far away because all that money which should have gone to assist the economy didn’t). I don’t believe for a moment that a true change in attitude will come until these honourable men are publicly vilified.

Rose

The honourable men of Rome were more than vilified after they killed Julius Caeser. They were killed. More from Shakespeare next week!

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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8 Comments on "Is it Possible China’s Steel Industry Has Excess Productive Capacity?"

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Annie
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Yes the Stern Hu situation gone quiet alright. What about the furore over the boat people and what happened the boat to catch fire? The media pursued it relentlessly but were told to wait for the report. Well that report is a long time coming and no-one seems to even think or ask about it anymore. Short memories.must have a…..shorrrtttttt..memory (apologies to midnight oil)

Coffee Addict
Guest
Dan. The August D&D is a good one because it highlights the need for all investors to make their own decisions, based on their own circumstances and perspectives rather than to follow any tip sheet blindly. I started sold down a number of energy holds this afernoon afternoon after buying some in the morning. Sounds like day trading. This is because you reminded me of the US situation and the reality that IF more bad news is in the pipeline POO will drop significantly (at least for a month or so). The cash can be reinvested when (if) new lows… Read more »
Pete
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CA: I agree about China. For all the mainstream “China is great” type of talk, there are equally as many non-mainstream articles explaining how Chinese data is distorted and reports incorrect. Do people honestly think that China can morph itself from an exporting economy into an internal consumption model so quickly? What happens to all the factories producing fake dog-poo (as someone else mentioned)? At the moment I think they are all smoke and mirrors. Pretend to be on top of all of the issues, and everyone believes you and acts accordingly. As for Mr Hu, I personally think it… Read more »
Greg Atkinson
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When I read all the hype about China it sounds very similar to the excitement about the “Asian Tiger” economies of the 1990’s. The Chinese economy has indeed had a good run, but all good things come to an end. It is not a question of if China will have a recession but a question of when. Maybe it won’t happen for five or ten years but when it does the Australian economic strategy of relying on China is going to become a real problem.

Gazzbag
Guest

here he is again

Peter-Simon
Guest
Comments for RIO and other ore miners 1)- It will be silly for anyone to believe in real business world that the seller will not want to know and collect as much data and information how much the customers can afford to pay (i.e. from buyers’ current needs and financial situation, from past history of their deals with different sellers) 2)- It is not normal or unwise that the top customer (especially) >50% of your product) does not have much to say in price than smaller customers. Especially for a buyer who can be your long-term financial health support. 3)-… Read more »
rick e
Guest

Hay Greg you have an admirer
Looking at the markets I notice the Asian stocks have fluctuated, how ever the ASX has followed the DOW, what ever happens in the US, OZ will follow but what % will be seen. It will be interesting time for OZ to see what happens if US has a very slow recovery and China is reaching its capacity at the moment.

Greg Atkinson
Guest

rick e I pay all admirers in beer ;) Actually I struggle to understand now why the Oz market follows the Dow as closely as it does but I guess the pull of the U.S. economy is still very strong. I agree it will be interesting to see what happens when China slows down a little…I wonder how long they can keep those unemployed factory workers busy building bridges etc?

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