Rising iron ore prices pointing to Chinese stimulus

Rising iron ore prices Chinese stimulus
The iron ore spot price has rallied in 2019.

As share markets see-saw up and down on daily speculation of the trade negotiations between the US and China, could rallying iron ore prices be showing that Chinese stimulus is on the way?

It certainly looks that way with the slumping iron ore spot prices that were a feature of last year now reversing and iron ore spot markets continuing to rally, closing at fresh multi-month or multi-year highs.

Strengthening Chinese steel demand and a relaxation of steel production restrictions have seen iron ore spot prices rise sharply, particularly for lower grade iron ore.

Iron ore price rise chart January 2019
Iron ore prices rising in recent months.

That has been great news for mining stocks including Andrew “Twiggy’’ Forrest’s Fortescue Metals (ASX: FMG) which has rallied from $3.55 in October last year to as high as $4.75 this month.

Pollution controls being relaxed

It is a little unusual for lower grade iron ores to lead the rally but some industry observers believe this is because there has been a relaxation of steel production restrictions over the Chinese winter.

Chinese steel output hit a record high of 928.3 million tonnes last year, a rise of 6.6% on 2017 but pollution restrictions and concerns about slower Chinese growth saw steel production slow towards the end of 2018.

In December, environmental curbs to improve air quality in northern China restricted steel production 76.12Mt, which was the smallest monthly total since March 2018.

Now the speculation is that these pollution restrictions will be wound back further as the Chinese Government becomes more concerned about slowing growth and providing economic stimulus.

The falling profitability of Chinese steel mills has reduced their preference for higher grade iron ore and boosted demand for cheaper, lower grade alternatives that are less efficient.

China slowing

The positive signs in the iron ore market comes as China’s economic expansion slowed in the face of the bruising trade fight with the US.

However, it is important to note that while the 6.6% growth rate for 2018 might be the slowest annual pace China has recorded since 1990, that still represents a positive impact on world trade because China more than twice as large as it was in 1990.

What has concerned the Chinese Government is that the economy was slowing towards the end of 2018, with fourth quarter growth just 6.4% compared to a year earlier.

That has led to some companies delaying hiring and even laying off workers, with the official jobless rate rising to 4.9% in December.

Some other indicators are showing trouble ahead for China, with indicators such as property sales, industrial output and retail sales slowing.

Slower wage growth and rising household debts are also causing Chinese consumers to tighten their purse strings.

Chinese slowdown engineered

Some of the Chinese slowdown has been deliberately engineered by President Xi Jinping’s three year campaign to contain debt and reduce financial risks.

That campaign cut back local government borrowing for new subway lines and factories so much that is has been reversed recently, although it will take some time for the stimulus to come through.

China’s leaders have prioritised promoting economic growth and after a December high-level meeting that mapped out the broad economic agenda for 2019, President Xi said growth must be maintained within “a reasonable range.”

That range is widely thought to be between 6% and 6.5%

Gradual stimulus on the way

Any stimulus package is unlikely to be as full blooded as the response to the GFC, which saw China’s economic growth accelerate but left a debt legacy that is still being dealt with.

This time the stimulus is more gradual, with the central bank injecting cash into the banking system to encourage lending and the central government removing strict controls on local borrowing.

Tax cuts are on the cards for businesses and individuals, particularly in the technology sector.

All of this is taking place as China and the US prepare for a new round of high-level trade negotiations at the end of January which will be trying to produce an agreement by March 1, when a three-month cease-fire Mr Xi and President Trump reached expires.

The results of those trade negotiations between the largest and second largest economies in the world will be crucial but so far it appears that both sides have a lot to gain by reaching a breakthrough.

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