Why This Isn’t the Bottom for Iron Ore

The big trucks transport iron ore
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Maybe this is the bottom for iron ore, the great red hope for Australia and the government.

Maybe a resurgent price will deliver a windfall for the government, boosting the budget and helping them to avoid the need for tax reform.

It would be handy, wouldn’t it? Because the government doesn’t have a tax reform agenda. Its only credible plan is scaremongering. I’ll get to that in a moment.

But first, a little hopium to kick off the week:

From today’s Financial Review:

Treasurer Scott Morrison is facing a potential multibillion-dollar revenue windfall as he prepares his first budget, with a surprising rally in the price of iron ore coming at just the right time for the government.

The commodity has surged to its highest level in three months – putting it back to about $US48 a tonne –as Chinese steelmakers ramp up production after their Lunar New Year break, a sign that global demand for iron ore could increase significantly in coming months.’

The simple fact is that the iron ore price jump relates to China’s massive surge in new credit over the month of January. China created a record amount of new debt last month. The figure was an astounding $525 billion.

Simon Rabinovitch, of the Financial Times, tweeted that if the new debt creation for the month were an economy, China’s January effort would make it the 27th largest in the world!

This is not the first time the iron ore price has received a boost from China’s attempts to stimulate its economy. During the iron ore bear market that began back in 2011, the iron ore price had big rallies in 2012, 2013, and a lesser one in 2015.

This is just another episode. The bottom line is that the market is in structural oversupply. The only way to improve the structure is via a falling price.

So this bounce will be short-lived, like the others. That’s especially the case because China isn’t managing its banking system very well. Soon after the news of January’s record credit creation, rumours surfaced that China would reign in some of the banks.

One minute they’re lending too little. The next they’re lending too much. In a major worry for the ongoing build-up of risk in China’s financial system, apparently 75% of January’s credit creation went to corporate borrowers, an already heavily indebted sector.

According to Bank of America Merrill Lynch much of the credit is going to local governments:

Today, 21st Century Business Herald cited a manager of a local government funding vehicle (LGFV) in a Western province as saying “the situation is completely different from last Jan’s – the banks are now chasing us to grant us loans.” This supports our findings late last year that the government seems to have abandoned its plan to curtail local government borrowings.

Hmmm. ‘Late last year’ was when the iron ore price bottomed. Traders obviously realised another credit induced demand surge was on its way. The question is; how long will the bounce continue? If the demand is just going towards more unproductive investments, which is the likely scenario, then it won’t last longer than a few more months.

For what’s it’s worth, the iron ore futures market isn’t overly excited about the recent price move. 2018 futures suggest a price of around US$32 per tonne.

So don’t expect the iron ore price to bail out your budget, Mr Morrison. The best you can hope for is a bounce into May to upgrade your long term price forecasts and delude yourself that you have more revenue to play with than you actually will.

In the meantime, Malcolm Turnbull can continue being a first class politician instead of the leader he portrayed himself to be when he booted Abbott from the top job.

Over the weekend, the Coalition realised that in the absence of a credible plan to combat Labor’s negative gearing reforms, they should just stick with the tried and true model of fear mongering. From the Australian:

Malcolm Turnbull has launched himself into the political fight over negative gearing, declaring every homeowner in Australia should fear Bill Shorten because his policy is calculated to “smash the residential housing market” and make all houses “worth less”.

In a hurriedly organised press conference yesterday, the Prime Minister attacked Labor’s negative gearing plans, predicting price falls in Sydney and Melbourne and reductions in the value of “every single house” if Labor were elected.

That’s how it works in Australian politics. Wait for someone to ‘do something’ and then attack it, ensuring that nothing gets done. This is what happens when the polls say you’re losing popularity. You go for the fear button.

No wonder Vern Gowdie is talking about the End of Australia. It’s virtually set in stone. As I’ll keep pointing out, you won’t see genuine reform in this country until you see a genuine crisis.

It’s chugging along slowly, so slowly that most people won’t see the signs until it’s too late. That’s why I suggest downloading Vern’s book. You can do so here, for free. At least you can face what’s coming with eyes wide open.

Given the ‘not too bad’ reporting season so far, there’s no urgency coming from any quarter. The fact that the share market is more than 20% off its highs, and still nowhere in sight of its 2007 peak, has more to do with an ‘irrational’ market than the stark reality of the situation.

But don’t forget, the earnings numbers coming through now are up until 31 December. The market has already factored these results in. It’s looking ahead now, into the second half of the year.

The fact that the main market index, the ASX 200, remains in a strong downtrend tells you the stock market doesn’t see an economic resurgence coming anytime soon. That could change of course, but if you have respect for your money, take note of what the market has to say over any self-serving ‘opinion’.

Greg Canavan,

For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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