Rebel Traders – Analysis Without The Hype

Another sign of the Chinese muddling in commodities has emerged when it was known that Chinese imports of Iron ore exceeds the demand by 50 million tons for this year.  Speculation (and accumulation of commodities) both by Chinese State authorities and Chinese private actors trying to front-run the expected recovery has brought up an excess of iron ore on the market, thus allowing no room for further upward evolution in iron ore prices.

China’s iron ore imports have exceeded actual demand by about 50 million tonnes so far this year and the oversupply leaves no room for further price rises, a senior official of the China Iron and Steel Association (CISA) said on Monday.

“We believe the Chinese iron ore price is largely influenced by speculation on the market,” CISA’s Vice Chairman Luo Bingsheng told reporters at the sideline of an industry conference in Beijing.

China imported 405 million tonnes of iron ore in the first eight months of this year, up 32 percent from a year earlier, to feed its rapidly growing steel output.

The country’s annual capacity is expected to top 700 million tonnes by the end of this year, with production of around 600 million tonnes of crude steel in 2009, hefty growth of 20 percent from the all-time high of 500 million tonnes in 2008.

The benchmark price of Indian origin ore with 63/63.5 percent iron in China has stabilised at about $90 per tonne, below the year’s peak of $115 hit in early August, but still above the contract price of about $75 cost and freight.

Additionally, Luo called for a revision of ongoing annual price talks, which he said would benefit both steel mills and miners, but gave no details.

“The traditional negotiation system no longer matches the current market situation. We think it is necessary to make some changes and adjustments, but they should be decided by both the buy side and the sell side,” Luo told reporters.

China broke the rule this year by agreeing to a 35 percent cut from 2008/09 prices with Australian upstart miner Fortescue Metals Group, despite the top miners’ “take or leave it” approach to the 33 percent price cut first reached by Rio Tinto and Japanese steel mills.

The annual conference involving CISA and the steel industry, led by top producer Baosteel, is traditionally seen as a warmup for annual term talks.

CISA Secretary General Shan Shanghua told Reuters earlier that his group would seek to change contract terms to the calendar year instead of the April-to-March fiscal year.

Shan also said talks over 2009/10 prices were continuing with Brazil’s Vale and Australia’s BHP Billiton six months into the contract year, but added that China was not in talks with Rio Tinto.

As regards overall steel production, whereas steel production fell all over the world Y/Y, in China the production beat its 2008 output (see below graph, courtesy of Steel Grips)

On the whole, the seel production alone would indicate a recovery if there wasn’t a serious issue of overcapacity in China. This overcapacity is forcing some Chinese steel mills to cut prices up to 58 $ per ton.

Despite this, the Chinese stimulus may provide for some nice results in Asian steelmakers.

Asia’s big steelmakers likely saw their earnings exceed expectations in the latest quarter on unexpected strength in China’s economy, though the spectre of oversupply looms as a key threat in the year ahead.

The sector is pulling out of the worst slump in decades thanks to stimulus measures by governments around the world, including China’s near $600 billion package focused on infrastructure that prompted a spurt in exports by JFE (5411.T), Nippon Steel (5401.T) and POSCO (005490.KS) to capture demand.

However, the issue that lies ahead, as previously mentioned is the Chinese oversupply… And there is not going to be a market sufficiently vigorous to catch up all that supply.

But the threat of oversupply from China clouds the outlook at a time when manufacturers are still cautious about spending for new plants, and housing and building starts remain in the doldrums.

Steel output at China has been growing at a rapid clip. The country’s annual capacity is expected to top 700 million tonnes by the end of this year, with production of around 600 million tonnes of crude steel in 2009, a hefty growth of 20 percent from the all-time high of 500 million tonnes in 2008.

Lakshmi Mittal, chairman of the world’s largest steelmaker, Arcelormittal, told the Financial
Times in a recent interview that prospects for a world steel industry rebound could be blown off course by a strong rise in exports from China.

We know that China has been putting a lot of efforts into obtaining cheap iron ore for its steel mills. Hence a surge in industrial production in China, notably of steel.

The problem (again), is that the steel is sold on the market by traders who have entered into future contracts at prices much higher than the current market price (and the market price in itself gives an idea of the tepid recovery taking place, even in China).

As it is, the Steel mills have been charging extremely high prices on their production, while the local demand is weak, and international demand almost non-existing.

As often repeated in these chronicles, Q4 will be the time of truth, for steel as well, as overcapacity is starting to hit the steel production.

Steel traders have urged large mills to cut their prices to reflect the market conditions, Caijing learned from a trader’s conference on Sept. 20.

Steel prices have fallen since August and many traders have lost money on products purchased under contract at higher than current market prices.

The contract price of cold-rolled steel for October delivery from Baosteel, for example, is 6,300 yuan per ton, compared with a market price of about 5,600 yuan per ton, Liu Changqing, chairman of Beijing Lange Baiziwan Steel Market, said.

Liu Yong, general manager of Anhui Huishang Metal Co., said his company bought 90 percent of the steel for a new project though the local markets.

Large steel mills should base their prices on what’s happening in the market or it will be “hard for mills and traders to reach a consensus,” Xu Jianlong, head of Jiangsu’s steel commerce chamber, said.

Meanwhile, steel mills should guarantee traders a discount on the market price, Xu said.

A large proportion of the steel produced by large mills is sold by traders, who resell it on the local markets.

Li Jianshe, marketing manager with steelmaker Magang Group, said steelmakers always consider their own interests first when the market deteriorates.

Meanwhile, the fourth quarter will be the most difficult time of year for domestic steel mills because weak demand will be unable to absorb fast-growing output and inventories, according to the China Iron and Steel Association.

Prime steel output grew for seven consecutive months to August, reaching a record 52.3 million tons in the month, far above the 40.4 million tons in February. In early August, prices stalled abruptly after a four-month rebound as ballooning output began to outpace demand.

Two of China’s main issues, i.e. unemployment and overcapacity had some measure of “good news” this week. In reports from China’s coastal regions (the most dynamic economically),  we learnt that while exports have started to pick up, employers are now having issues with finding laborers.  As I mentioned earlier, several millions of Chinese laborers returned to the country earlier because of hardship in the cities. With the demand picking over, these laborers are now in short supply in those economically active areas of China.

Although China’s employment situation is still grave, a shortfall in labor resources has cropped up in some coastal regions as both domestic and world economy are making positive changes.

“Finding workers is my priority now as export orders have started to pick up since June,” said Xiao Senlin, a senior manager of the Ha Yi Dai Toy Factory, which is based in the booming city of Dongguan in China’s manufacturing base Guangdong province.

(…)

Xiao’s company was not the only example of the impact of labor shortages. A lack of workers is spreading in export-oriented enterprises in two of the country’s major manufacturing bases: the Pearl River Delta and Yangtze River Delta regions, as orders pile up.

Those suffering labor shortages are most small and medium-sized enterprises, which are China’s major employers of migrant workers.

Wenzhou, a coastal city in eastern Zhejiang province, estimated a rural labor resource shortage of 150,000, most in some traditional labor-intensive sectors such as spectacles, garments, shoes and electronic goods manufacturing.

Like Xiao, Chen Aimin, a human resources department manager at Kuoshuai Garment Company in Wenzhou, was in a dilemma — he was happy to see order increase but worried about a lack of workers.

“We did not expect that our orders for the second half this year would be 40 percent more than last year,” Chen said. “As a result, we did not employ enough workers and now it becomes difficult to recruit new workers.”

According to Wenzhou customs statistics, the city’s garment exports rose 10 percent in July from a year earlier while shoe exports gained 2.7 percent year-on-year. However, compared with June, garment exports increased 12 percent last month and shoe exports surged 35 percent. The two sectors’ exports accounted for 45 percent of the city’s total export volume.

Although exports, a bedrock that fueled China’s fast growth in the past few years, fell on a year-on-year basis last month, there were signs of improvement. July exports fell 23 percent from a year earlier, but increased 10.4 percent from June.

But some analysts warn that this increase could only be due to “seasonality” and a preparation for the Christmas season.

However, some analysts warned the current labor scarcity after the export order increase was mainly a result of seasonal factors instead of solid growth in external demand.

Most of the order increase was from daily necessities as foreign retailers started buying for the coming Christmas shopping season, said Zeng Shuiliang, an expert with the Yangtze Delta Region Institute of Tsinghua University.

On the longer-term, this could redistribute the economy of the region and favor the development of regions until left far behind in their economic development:

Besides the economic uncertainties that may hinder employment, some far-sighted experts are pointing to labor resource conflicts between the country’s coastal region and the relatively under-developed western region.

In southwestern Chongqing, one of the country’s major sources of migrant workers, going to the east coast to be a migrant worker is no longer an attractive option.

Compared with Chongqing, the earning in the coastal regions was not as attractive as it used to be, said Sun Huiju, manager of a local labor service export agency. Meanwhile, many of these home-returning migrant workers got re-employed locally and did not want to leave their hometown again, Sun said.

Labor resource conflict between the country’s east and west would be natural in the long term as the western regions’ economic development picked up and people’s earnings increased, said Wang Ying, a workforce official in Chongqing.

The backflow of migrant workers to the western regions would help industrial structure adjustment, Wang said.

However, even as the recovery appears to be still weak on the global plane and as inventory reconstitution can only go so far, the Chinese authorities have started addressing the issues of overcapacity we have been talking about on this blog for some times now.

China’s cabinet said it will make efforts to curb overcapacity and investment in the steel and cement industries, among others that may be overheating due to China’s stimulus plan, AP reported, citing state media. Industry regulators will “enhance management” of other industries including flat glass, wind power, polysilicon production and chemicals, the Xinhua New Agency reported, following a cabinet meeting led by Premier Wen Jiabao. The cabinet also said it would take measures to strictly enforce both environmental standards and market access. China’s US$586 billion economic stimulus package has led steel and cement manufacturers to step up production for public works projects, leading some economists and business leaders to warn of excess capacity across industries.

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