Chinese property, banking pain has iron ore in bear pressure

Rio appears to be doing a pretty good job of controlling those costs, and there are new opportunities in terms of improving operational efficiency, including the first ore from the vital new Gudai-Darri mine.

But it’s hard to shake off concerns that Australia’s big iron ore miners are facing worrying pressure, with falling demand and rising costs conspiring to stifle profitability.

That’s important for investors – Rio’s shares fell 2.6 percent on Friday, picking up losses since their recent peak last month to 21 percent, while BHP fell 24 percent over the same period – but also for Australia’s state and federal governments, for which royalties and strong iron ore taxes have been a boon over the last few years.

The supply side is not an issue here, given that large iron ore miners have strong cost discipline and keep volumes under control. But the demand picture is deteriorating as China’s economy continues to suffer.

China’s economy is treading water

One of Australia’s most senior iron ore miners told Chanticleer that understanding what’s really going on on the ground in China has become increasingly difficult due to the COVID-19 border closure, but the data we’re seeing isn’t encouraging.

Sluggish GDP figures released by the Chinese government on Friday confirmed the economy was treading water. GDP grew just 0.4 percent in the second quarter compared to a year earlier, against expectations of 1 percent growth.

There was a slight rebound in activity, particularly retail spending in June, as lockdowns were eased, but it’s inevitable the fact that this is increasingly looking like a lost year for the Chinese economy.

The danger here is that mortgage boycotts widen into a more systemic threat to the financial system, a flashpoint for social unrest, or both.

According to Credit Agricole, the economy needs to grow by 8.5 percent in the second half of the calendar year to reach the country’s 2022 GDP target of 5.5 percent. That looks a near-impossible task given that President Xi Jinping’s zero COVID policy – which was reiterated as recently as this week – is now being tested by a new outbreak in Shanghai.

Within Australia’s big iron ore miners, the view is that the Chinese government’s big promises of stimulus measures are having an impact, but the lockdown appears to be limiting the number of infrastructure projects moving from the planning stage to the implementation stage.

Weak demand from the infrastructure sector (about 30 percent of China’s steel demand) means that Chinese steelmakers, who built large stocks in the first half of the year in anticipation of a stimulus spike, are losing money and slowing production, forcing prices down. of iron ore.

A major Australian miner stressed that there were no problems with suspended deliveries. But iron ore producers want to see an increase in infrastructure activity in August and September so that steel stocks decline and demand (and hopefully prices) for iron ore increases.

Mortgage boycott payments

Demand for iron ore is also muted by the ongoing turmoil in China’s property sector, which accounts for between 20 percent and 30 percent of China’s steel demand.

Here, longstanding worries about the debts of big property developers threaten to turn into a full-blown mortgage crisis.

Chinese financial stocks lost 1.4 percent in trading on Friday, and have fallen for a 10th straight day in their longest losing streak, on reports that a growing number of Chinese property owners are refusing to pay mortgages on properties in unfinished projects.

China Real Estate Information Corporation reported that homebuyers had halted mortgage payments on at least 100 unfinished projects in more than 50 cities as of Wednesday. What is particularly worrying is that the figures show a rapidly growing trend, up from 28 projects on Monday and then 58 projects on Tuesday.

There are three interrelated reasons that pawnshops can boycott payments.

First, there are concerns that faltering property developers will go out of business before the project is complete. Defaults and pending debt payments have basically continued for a year, ever since the issues surrounding Evergrande.

Nomura economists this week estimated that Chinese developers shipped only about 60 percent of the homes they sold between 2013 and 2020 — a period during which China’s mortgage debt rose by $4 trillion.

Second, there are concerns that banks, which have an estimated $6.8 trillion in mortgages and $1.9 trillion in other loans to developers, could crack under the property’s debt burden. A series of bank runs in recent weeks in lenders freezing developers have raised concerns about fragility in the sector.

Finally, there is clear concern that the recent drop in home prices – down for the 10th straight month in June – means properties are worth less than consumers are paying for them.

The problem needs to be seen in some context; Chinese banks have placed the value of the mortgages affected by the boycott of payments at $US312 million, which is clearly very small in the scheme of this behemoth asset class.

And Chinese regulators said late Thursday they would work with local governments to finalize these projects. Although, as with many recent government policies, it remains to be seen whether promises turn into execution.

The danger here is that the mortgage boycott escalates into a more systemic threat to the financial system, a flashpoint for social unrest, or both.

Morgan Stanley, which believes about 188 million square meters of property across 1.7 million units could be at risk, sees contagion as a major risk as a kind of vicious circle emerges.

“Homebuyer confidence has weakened further from a low starting point, leading to further declines in property sales. This may force more developers, even today’s relatively powerful ones, to suspend unfinished projects, continuing the downward trend,” he said.

“In the meantime, housing prices may continue to fall, exacerbating the downward spiral. In addition, the stress on the housing sector could spread to the wider economy, given the broad inter-sectoral links, while being magnified by the financial system.”

Of course, perhaps China will soon solve the problem of stubborn mortgages. Let’s face it, the Chinese government has proven quite adept at containing other examples of social unrest, including the anger of the COVID-19 lockdown in Shanghai.

But other problems will be more difficult to solve. Relying on local governments to help complete projects will require money and coordination, and may not be easy given the COVID restrictions.

More broadly, Morgan Stanley said Chinese policymakers “likely need to send a clear and strong signal that they are prepared to be a ‘rescue of last resort’ to control systemic risk”. It would also be an expensive and complicated process.

Obviously, the Chinese property meltdown will be a major concern for Australian iron ore miners, who will be hoping that the friction will pass, and a massive debt-driven stimulus package from the Chinese government will once again ignite the fire under commodity prices.

History is on their side. But a series of complications – a deadly virus, a slowing global economy and a heavily indebted property sector starting to show signs of cracking – mean the pressure on iron ore prices will continue.

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