ASX 200 advance slows as iron ore falls

Iron ore found support at $60.

Iron ore

The ASX 300 Metals & Mining Index has taken some encouragement from the rally, with support at 2850. But bear rallies are normally short in duration and reverse sharply.

ASX 300 Metals & Mining

The ASX 200 advance has slowed after the recent sell-off in the resources sector. But rising Twiggs Money Flow still signals buying pressure and another attempt at 6000 seems likely.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

ASX 300 Banks, the largest sector in the broad index, is consolidating above its new support level at 9000. Declining Twiggs Money Flow warns of medium-term selling pressure. Reversal below 8900 is unlikely but would warn of a correction.

ASX 300 Banks

Bank exposure to residential mortgages is the Achilles heel of the Australian economy and APRA is likely to keep the pressure on banks to raise lending standards and increase capital reserves, which would lower return on equity.

IMF predicts Australian GDP rise but iron ore drops

From Latika Bourke at Sydney Morning Herald:

Australian economy to boom as unemployment drops, IMF

…The IMF predicts Australia’s economy will grow by 3.1 per cent in 2017 and 3 per cent in 2018. This is better than the most recent forecast by the Australian Treasury and released by the Australian government in December last year, which predicted GDP would “pick up to 2¾ per cent in 2017-18 as the detraction from mining investment eases.”

Broad projections like those of the IMF offer little comfort. The very next headline warns of falling iron ore prices:

From Timothy Moore at The Age:

Spot iron ore extends retreat, sliding another 4.6pc

The spot price of iron ore now has fallen one-third from its February peak, as the slide into a bear market turns into an accelerating rout.

At its Tuesday fix, ore with 62 per cent iron content slid $US3.05, or 4.6 per cent, to $US63.20 a tonne, according to Metal Bulletin. The price has tumbled more than 20 per cent so far this month….

Breach of the rising trendline warns that spot iron ore is likely to test primary support at 50. Reversal of 13-week Twiggs Momentum below zero warns of a primary down-trend.

Iron Ore Spot Price

Falling resources stocks are dragging the ASX 200 lower. The up-trend is still intact but expect strong resistance at 6000. Reversal below 5680 would signal reversal to a down-trend.

ASX 200

Falling iron ore weighs on Resources stocks

Iron ore broke support at 70. Follow-through below the rising trendline would warn that the up-trend is weakening.

Iron Ore

Australian resources stocks, represented here by the ASX 300 Metals & Mining Index [$XMM], reflect strong selling pressure with a bearish divergence on Twiggs Money Flow. Follow-through below 2850 would warn of a (primary) reversal.

ASX 300 Metals & Mining Index

3 Headwinds facing the ASX 200

The ASX 200 broke through stubborn resistance at 5800 but is struggling to reach 6000.

ASX 200

There are three headwinds that make me believe that the index will struggle to break 6000:

Shuttering of the motor industry

The last vehicles will roll off production lines in October this year. A 2016 study by Valadkhani & Smyth estimates the number of direct and indirect job losses at more than 20,000.

Full time job losses from collapse of motor vehicle industry in Australia

But this does not take into account the vacuum left by the loss of scientific, technology and engineering skills and the impact this will have on other industries.

…R&D-intensive manufacturing industries, such as the motor vehicle industry, play an important role in the process of technology diffusion. These findings are consistent with the argument in the Bracks report that R&D is a linchpin of the Australian automotive sector and that there are important knowledge spillovers to other industries.

Collapse of the housing bubble

An oversupply of apartments will lead to falling prices, with heavy discounting already evident in Melbourne as developers attempt to clear units. Bank lending will slow as prices fall and spillover into the broader housing market seems inevitable. Especially when:

  • Current prices are supported by strong immigration flows which are bound to lead to a political backlash if not curtailed;
  • The RBA is low on ammunition; and
  • Australian households are leveraged to the eyeballs — the highest level of Debt to Disposable Income of any OECD nation.

Debt to Disposable Income

Falling demand for iron ore & coal

China is headed for a contraction, with a sharp down-turn in growth of M1 money supply warning of tighter liquidity. Falling housing prices and record iron ore inventory levels are both likely to drive iron ore and coal prices lower.

China M1 Money Supply Growth

Australia has survived the last decade on Mr Micawber style economic management, with something always turning up at just the right moment — like the massive 2009-2010 stimulus on the chart above — to rescue the economy from disaster. But sooner or later our luck will run out. As any trader will tell you: Hope isn’t a strategy.

“I have no doubt I shall, please Heaven, begin to be more beforehand with the world, and to live in a perfectly new manner, if — if, in short, anything turns up.”

~ Wilkins Micawber from David Copperfield by Charles Dickens

Iron Ore Wrap

From Andy Semple at Andika:

The iron ore price has slumped to a one-month low as investors fret over the strength of Chinese demand. The commodity weakened 1.7% to $US53.50 a tonne at the end of last week, its lowest price since April 11. It’s the commodity’s seventh red session in the past eight and the price has now dropped to below the [Australian] government’s recent budget forecast of $US55 a tonne.

Iron ore: Only question now is how rapid the fall | MINING.com

From Frik Els:

According to Platts Mineral Value Service, a Munich-based iron ore and steel research company, domestic iron ore’s contribution to the Chinese steel market has declined from 36% of market share in 2010 to around 22% in 2015.

Domestic iron ore output from an industry plagued by fragmentation, high costs and low grades (only around 20% Fe) has halved since 2013 and may dip below 200 million tonnes Fe 62% equivalent this year…..

Even if more Chinese mines shut down and the shift to seaborne ore continues, the seaborne market is not exactly short of tonnage. All-in-all new seaborne supply set to increase by approximately 245 million tonnes by end of 2018 according to Platts MVS.

The big three – Vale, Rio Tinto and BHP Billiton – last week lowered future production guidance, but the aggregate 35 million tonnes in possible lost production hardly changes the oversupply picture and the giants would still hit actual annual output records even at these lowered levels. Citigroup’s analysts expect around an additional 75 million tonnes of iron ore this year to be shipped out of Australia, more than a third of which would come from Roy Hill. The Gina Rinehart mine has brought forward ramp-up plans and now expects to be producing at full annualized capacity of 55 million tonnes by the end of this year. Later this year, Rio’s board is likely to give the go-ahead to build Silvergrass which would add another 20 million tonnes of high-grade, low cost ore to the company’s Pilbara output.

Source: Iron ore price: Only question now is how rapid the fall | MINING.com

The future of Chinese steel | MacroBusiness

Chinese Steel

From Andrew Batson’s interview with Cai Rang, chairman of the China Iron & Steel Research Institute Group:

China’s current steel production capacity is 1.2 billion tons, but domestic demand cannot completely absorb this capacity. In 2015 China exported about 100 million tons of steel products; this was a relief for domestic capacity but a shock to the international market. Already nine European countries have made antidumping complaints, and Japan, Korea and India have also complained. This shows that our country’s current steel production capacity is not sustainable, and must be genuinely reduced.

Now the relevant departments are drafting the 13th five-year plan for the iron and steel industry, and the preliminary plan is to first cut 200 million tons, and eventually stabilize steel capacity around 700 million tons.

How will a 40 percent cut in Chinese steel production impact on Australian iron ore exports? Not well, I suspect.

Source: The future of Chinese steel – MacroBusiness

Sigh…no, iron ore has not bottomed | MacroBusiness

From David Llewellyn-Smith:

…..restocking is the only thing going on here, enhanced by recent Chinese stimulus. It will pass in due course leaving enormous oversupply and far too large Chinese inventories.

….Not only is iron ore going below $30, it’s going below $20 soon enough. This year we’ll see more supply from Minas Rio, Sino, Roy Hill, India and Vale as Chinese demand falls sharply with a swing in the market of 100mt towards greater surplus.

Source: Sigh…no, iron ore has not bottomed – MacroBusiness

China: Cement Production

Lowest cement production in more than 10 years reflects the decline in infrastructure investment. Not good news for Australian resources stocks. Where cement production goes, iron ore and coal are likely to follow.

Goldman describes Australia’s lost decade | Macrobusiness

Posted by Houses and Holes. Reproduced with kind permission from Macrobusiness.

Goldman’s Tim Toohey has quantified the unwinding commodity super-cycle for ‘Straya’:

Lower commodity prices risk $0.5trn in forgone earnings
The outlook for revenues from Australian LNG and bulk commodities shipments – which account for almost half of total export earnings – has deteriorated significantly. To be clear, overall revenues are still forecast to increase substantially over the coming years – underpinned by a broadly unchanged strong outlook for physical shipments (particularly for LNG). However, in a nominal sense, the outlook is far less positive than before. This owes to a structurally weaker price environment, with GS downgrades of 18% to 25% to key long term price forecasts for LNG and bulk commodities suggesting that cumulative earnings over the years to 2025 are on track to be ~$0.5trn lower than previously forecast.

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… and will erode Australia’s trade/fiscal positions
The deterioration in the earnings environment naturally has direct implications for Australia’s international trade and fiscal positions. On the former, a return to surplus by CY18 no longer looks feasible, and we now expect a deficit of ~$15bn. On the latter, relative to the 2014 Commonwealth Budget, we estimate that weaker commodity prices will cause a ~$40bn shortfall in tax revenues over the next four years. Given our expectation that Australia’s LNG sector will deliver no additional PRRT revenues over the coming decade, and the ~$18bn downgrade to commodity-related tax in the December MYEFO, we therefore see a risk of further material revenue downgrades at May’s 2015 Budget.

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Resulting in changed GDP, RBA cash rate and FX forecasts
Although the commodity export changes mainly manifest through the nominal economy, there are significant impacts back through to the real economy. Lower export earnings result in lower profits, lower tax receipts, lower investment and lower employment. We continue to expect just 2.0% GDP growth in 2015 but have lowered our 2016 to 2018 real GDP forecasts by an average of 50ppts in each calendar year. As a consequence, we have moved forward the timing of the next RBA rate cut to May 2015, where we see the cash rate remaining at 2.0% until Q416, where we expect a 25bp hike. We now expect just 75bps of hikes in 2017 to 3.0% and rates on hold  in 2018. Despite the recent move in the A$ towards our 75c 12 month target, the reassessment of the medium term forecast outlook argues for a new lower target 12 month target of 72c.

OK, that’s quite a piece of work and congratulations to Tim Toohey for getting so far ahead of pack. I have just two points to add.

The LNG forecasts look good but as gloomy as his iron ore outlook is, it is not gloomy enough. $40 is a more reasonable price projection for 2016-18 and we’ll only climb out of that very slowly. That makes the dollar and interest rate forecasts far too bullish and hawkish.

Second, even after these downgrades, Mr Toohey still has growth of 3.25% GDP penned in for 2016 and 3.5% for 2017. We’ll have strong net exports and is about it. With the capex unwind running right through both years, housing construction to stop adding to growth by next year, the car industry wind-down at the same time, political strife destroying the public infrastructure pipeline, the terms of trade crashing throughout and households battered half to death by all of it, those targets are of the stretch variety, to say the least.

The analysis is exceptional, The conclusions, sadly, overly optimistic.

Correlation Breakdown as Proxies for Risk Boost Aussie, Kiwi – Bloomberg

The strength of the Aussie is increasingly driven by reasons other than raw materials as growth slows for exports to China, its largest trading partner. Prices for iron ore delivered to the port of Tianjin have dropped to the lowest level since December 2009, according to Steel Index Ltd., and contracts for coal used to make steel may fall 11 percent to the lowest price in two years, according to a Bloomberg survey of seven analysts and industry officials.

via Correlation Breakdown as Proxies for Risk Boost Aussie, Kiwi – Bloomberg.

Terms of trade taking a hammering | | MacroBusiness

As predicted, coking coal is now breaking down in sympathy with iron ore. …..That’s 10% in two weeks. Thermal coal is down 10% in two months. Ore is now down over 20% in two months. These three commodities make up 50% of the [Australian] terms of trade.

via Terms of trade taking a hammering | | MacroBusiness.

Free steak knives with your boom! | | MacroBusiness

Houses and Holes: Thermal coal is already at a price that is uneconomic for many mines and if iron ore were to settle in the $110 region, which is my call, then the margins for many an iron ore hopeful are looking suddenly thin too. If this keeps up for a few months then the next phase of the boom for Australia is pulled capex.

via Free steak knives with your boom! | | MacroBusiness.

The China-driven commodities super-cycle debate: Nomura edition

Nomura: We have performed a detailed analysis of metal intensity of GDP for steel, copper and aluminium in the following pages, which we believe clearly outlines our view that China’s economy is not large enough (in GDP terms) to support a continuation of the rapid growth in metal consumption seen in 2000-11.

Our conclusions are based on an analysis of China’s metal intensity of GDP rather than metal consumption per capita, and reflect a simple premise that while a country’s population size may be an important indicator of a country’s potential demand for industrial metals (per capita), the ability to meet potential demand is determined by the quantity of metal consumed in relation to the size of economic output (ie, GDP, not GDP per capita). Hence, in our view, metal intensity of GDP is a more important variable to monitor than per capita metal consumption.

Zarathustra: The reason is that, according to Nomura, the per-capita analysis ignores the composition of China’s GDP growth. China’s investment driven growth is very metal intensive.

via The China-driven commodities super-cycle debate: Nomura edition.

Chinese economics: Is iron ore demand real?

Reuters video: Nicholas Zhu, ANZ Bank head of macro-economic data Asia, examines iron ore stockpiles at Qingdao port.

Hat tip to Houses and Holes

BHP: China Iron Ore Demand ‘Flattening Out’ – WSJ.com

STEPHEN BELL: China’s demand for iron ore is ‘flattening out’, a senior executive at BHP Billiton Ltd. said Tuesday.

Demand growth for the commodity used to make steel will drop “to single digits if it is not already there,” Ian Ashby told a press conference in Perth.

via BHP: China Iron Ore Demand 'Flattening Out' – WSJ.com.

Bulk trouble – macrobusiness.com.au

These three commodities [thermal coal, coking coal and iron ore] make up half of Australia’s terms of trade. The first few months of next year are not going to be kind to the TOT. Not kind at all.

via Bulk trouble – macrobusiness.com.au | macrobusiness.com.au.

Thermal coal:

Thermal Coal

Coking coal:

Coking Coal

Iron ore:

Coking Coal