Aussie iron ore giants received some good news on Monday. Chinese manufacturing data for May bettered market expectations slightly. Both BHP Billiton [ASX:BHP] and Rio Tinto [ASX:RIO] will welcome the respite that this brings.
They deserve a bit of good news after all. It’s been a turbulent year for iron ore. It’s only worsened in the last few months as prices plummeted closer to US$50 a tonne. So how important are the positive manufacturing figures?
They’re not earth shattering. But they suggest that steel demand is rising which should help the iron ore industry stabilise after months of uncertainty over future spot prices.
The figures themselves don’t look too impressive at first sight. The government-backed Purchasing Managers Index (PMI) for May edged up by 0.1 points to 50.2 points. Simply put, it indicates that the manufacturing sector is operating above its long term average. And it backs up the trend in rising iron ore prices in the last few weeks.
In recent weeks the price of the mineral has settled above US$60 per tonne. It’s not at the US$180 level it was in the mining boom’s heyday. But it’s still a reasonable improvement from the US$50 lows seen as recently as March.
So what does the manufacturing data tell us?
For one, it proves that construction orders are normalising again. Construction orders for materials like steel contribute to total manufacturing output. So a higher PMI number suggests construction across the economy is picking up again.
That matters deeply to iron ore exporters. New property developments make up one third of all steel demand in China. As long China keeps building new dwellings, their demand for iron ore will remain strong.
So the PMI index indicates that construction has recovered to a more stable level. Sure, construction isn’t booming as it once was, but at least it’s not falling anymore.
Rising construction orders bucks the trend of slowing residential construction in China. But it remains to be seen whether construction can continue growing. The concerns over lagging rural migration to cities are an ongoing problem for builders. Without millions of new migrants to house, they’ll be relying on investors to keep housing demand high.
On top of slowing migration, China already has an over-abundance of residential dwellings. You’ve probably seen China’s ‘ghost cities’ at their most extreme — huge skyscrapers with no people in sight. That oversupply of housing is partly to blame for falling property prices in China in the past six months. House prices fell by 0.28% in the fourth quarter of 2014. That was a substantial drop from the second and third quarters in 2014, where prices grew by 2.22% and 2.23% respectively.
Naturally, these difficult property market conditions had a negative effect on demand for iron ore. This was as important in driving down prices as BHP’s and Rio’s own expansion strategies. Now that manufacturing is showing signs of recovery as demand for iron ore lifts, hopefully prices will stabilise.
China’s monetary easing is slowly beginning to work
China still has ambitions to hit its 7% GDP growth rate for 2015. The manufacturing data for May is a sign that things may be moving in the right direction. That’s important for one key reason. It shows that China’s aggressive monetary easing program is paying off.
In the past six months, the PBoC cut interest rates on three separate occasions. In total, the cash rate dropped by 0.60% to its present 5.1% level.
On top of this, banks have been given greater license to lend money. Their capital requirements have been eased. That reduces the amount of money they need to hold to lend to borrowers. The cheaper credit, and the laxity in lending restrictions, helps explain why construction picked up during May.
Yet there is one caveat to this. Did they really need three rate cuts to lift demand for new construction? Evidently, they did. But we shouldn’t forget that China’s interest rates are still at a relatively high 5.1%. The Chinese have been aggressive about lifting spending, but they have plenty of scope to keep stimulating the economy.
Contributor, The Daily Reckoning
PS: Despite a slowing economy, growth rates of 7% in China still present huge opportunities for Australia. And not just in iron ore, but across all sectors of the economy. Don’t forget that a new free trade agreement is kicking off in June. That will help open up new opportunities for services, healthcare and tourism.
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