(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, Feb 28 (Reuters) - Chinese steel production rose by 7.4 percent in January compared with a year earlier, according to the World Steel Association (WSA).
A few years ago such a growth rate would have been viewed as normal, even perhaps as a bit on the weak side.
But after three years of flat or falling output, it’s something of a stand-out.
True, this is still an estimate by the WSA. The official figures from China are still pending as the local steel association CISA aggregates two months data over the start of any calendar year due to the disruptive effect of the Chinese New Year holidays.
But the direction of travel has been clear for some time now. Chinese steel output returned to growth around the second quarter of last year and has been accelerating ever since.
This, it is worth emphasising, is not how things were supposed to be. It’s only a year ago that the world’s big iron ore miners were lamenting the passing of the Chinese-fuelled “super-cycle” and girding themselves for a period of low pricing.
The subsequent surge in iron ore price, currently trading above $90 per tonne on a spot basis, has been as unexpected as was the original collapse.
Is it all a bubble? Or is it for real?
On that question hangs not just the outlook for the iron ore price but that of just about every industrial commodity.
Graphic on China’s steel production:
Graphic on China’s steel exports:
There’s another unexpected development when it comes to China’s huge steel sector.
As production has risen, exports have fallen.
This time last year China’s soaring steel exports were generating such a collective reaction from the rest of the world that the issue moved onto the G20 agenda.
Exports of steel products averaged 9.5 million tonnes per month in the first half of 2016. The rate dropped to 8.6 million over the second half of the year. January’s export rate was 7.4 million tonnes, the lowest monthly reading since June 2014.
Trade sanctions have proliferated in the interim but there are plenty of gaps between the multiple trade barriers if Chinese exporters were minded to exploit them.
Rather, the simplest explanation is that less steel is seeping out of China because domestic demand is so robust.
Chinese exports of steel, similar to those of aluminium products, have historically acted as a safety valve for over-production relative to local demand. That safety valve, it seems, is less needed right now.
The single most important driver of increased domestic steel demand has been the stimulus package launched by Chinese policy-makers at the beginning of 2016.
Having told everyone that China would transition away from its old fixed-asset-investment model, Beijing flip-flopped in the face of slowing growth and did exactly what it had done in the past, namely pump money into infrastructure and construction.
Steel, and its key metallic input iron ore, is always the first-stage beneficiary of such activity. No surprise then that Chinese steel producers responded to this renewed demand spurt.
But China has learnt the lessons of past stimulus, which has generated unintended consequences in terms of excess industrial capacity and ghost cities.
All other things being equal, Beijing would be expected to rein in spending just as soon as it can, which is why most metals analysts have been extremely cautious about the demand outlook beyond the next quarter or so.
But, something else is happening now, according to analysts at Goldman Sachs.
Credit to what the bank terms China’s metals-intensive “old economy” has not only not slowed but has actually accelerated.
“Over the two months to January 2016, China’s ‘old economy’ received 2.2 trillion renminbi of medium and long term loans, which was in turn used to fund metals intensive property developments, manufacturing capacity additions, infrastructure projects and property purchases, driving a nine-percent acceleration in Chinese FAI growth over the following two months, and more broadly, underpinning the 2016 commodity price boom”. (“Metal Detector”, Feb. 16, 2017).
Credit to the “old economy” in the two months to January 2017 totalled 3.3 trillion renminbi, a 50-percent increase on the year-earlier level.
And, critically, this is not the government pushing credit into the economy, but rather the economy, particularly the private sector, demanding and receiving more credit, according to Goldman Sachs.
Which is where Beijing’s supply-side reform comes into play.
It should be clear by now that China’s ongoing campaign to eliminate steel capacity hasn’t affected the country’s ability to make more of the stuff.
That’s because much of what has been closed was either already-idled capacity or “zombie” plants, still operating but only to generate sufficient cash flow to service debt.
The ongoing removal of such dead weight has caused profitability to surge across the rest of the steel sector.
Profitable companies look to invest and profitable companies are more likely to qualify for bank loans.
Such “organic” credit growth, as Goldman calls it, is going to be more sustainable than that dependent on Beijing’s stimulus policy.
Goldman contends that the flow-through effects of this renewed “old economy” credit surge haven’t even really begun yet.
That’s not to say that they are not in the iron ore price. There is certainly a degree of exuberance in China’s exchange-traded iron ore price, although it’s rational rather than irrational exuberance.
The more intriguing question is whether this new credit growth is in the price of other metallic commodities such as copper or zinc.
The base metals have also rallied over the past few months but not nearly as dramatically as iron ore. Moreover, they have done so in large part on a narrative of supply constraint, witness copper’s current fixation with the twin disruptions caused by the strike at the Escondida mine in Chile and the suspension of operations at the Grasberg mine in Indonesia.
A stronger-than-expected performance by China’s “old economy” has arguably yet to be factored in.
Steel is ahead of the curve simply because it’s what tends to get used first in new construction.
That’s why Chinese production is accelerating so sharply and exports are falling. As long as they continue doing so, they will be serving as a pointer as to where the rest of the metallic complex may be heading.
Editing by Jane Merriman