How Prudent is the Bet on Iron Ore Miners Over China’s Recovery? – BHP, Rio, and FMG

  • April 24, 2020 08:06 PM AEST
  • Kunal Sawhney
    Kunal Sawhney
    CEO Kunal Sawhney
    2781 Posts

    Kunal Sawhney is founder & CEO at Kalkine and is a richly experienced and accomplished financial professional with a wealth of knowledge in the Australian Equities Market. Kunal obtained a Master of Business Administration degree from University of T...

How Prudent is the Bet on Iron Ore Miners Over China’s Recovery? – BHP, Rio, and FMG

Iron ore mining companies such as BHP Group Limited (ASX:BHP), Rio Tinto Limited (ASX:RIO), and Fortescue Metal Holdings Limited (ASX:FMG) are majorly betting on China, and they have all the reason to do so after all the red dragon is undergoing a revival post remaining hand strung by the COVID-19 outbreak for quite some time.

While iron ore mining companies across the continent are planing over the slight recovery in the Chinese economy, the market seems to be liking the optimism with stocks of major iron ore miners recovering at a steady pace.

But, as far as the art of investing is considered, it is always pragmatic to analyse both the qualitative and quantitative measures to explore an opportunity, when it presents itself.

At Kalkine, we would try to put together relevant pieces of information, which could come handy to clear the dust around ASX-listed iron ore stocks, which currently seems to be a hot trade, considering the recent price action.

Economic Figures Lower Falling Pace for March 2020 Across China

The nominal urban fixed investment across China, which dropped by 16.1 per cent on a YTD basis (as on 31 March 2020) against the previous year, witnessed a less steep decline in March 2020 as compared to February 2020.

The urban investment contracted 24.5 per cent from January to February 2020; however, expanded by 6.1 per cent in March on a month-on-month basis, contrasting with 22.1 per cent drop in February 2020.

Likewise, the industrial production across China also witnessed a slower pace of fall. The industrial production till March 2020 declined by 1.1 per cent against the previous year, including a contraction of 13.5 per cent from January to February 2020 and a rebound of 32.1 per cent on a month-on-month seasonally-adjusted basis in March 2020.

The retail sales figures across China also improved slightly for March with an increase of 0.2 per cent on a seasonally-adjusted basis.

However, while March 2020 has witnessed a halt in the ongoing decline across many fronts, including retail sales, urban investment, and industrial production, it should also be kept in mind that the overall trend for 2020 is still on a decline as compared to the pre-crisis level in 2019.

For example, the retail sales which saw an expansion of 0.2 per cent on a monthly seasonally-adjusted basis are on a decline with retail sales tumbling by 15.8 per cent against the previous corresponding period from January to March 2020.; and,

  • The major risk which China faces in maintaining the positive trajectory of March 2020 figures is the possibility of a second wave of infections emerging.

The global economy is under peril, and the International Monetary Fund (or IMF) has already forecasted a contraction of 3 per cent on the global front for the year. It also anticipates that advanced economies such as the United States, European nations, would take a major fall.

To Know More, Do Read: Why US-Backed OPEC+ Production Cut Is a Failed Stimulus in the Status Quo?

The global economies are expected to take a considerable hit due to the COVID-19 outbreak, but China seems to have moved forward from intensive containment of COVID-19 to early indications of economic recovery, as depicted by the above-presented figures.

While the majority of heavy industrial activity had restarted as of the end of March 2020 across China, activities across sector and region vary considerably, and now, the arc of recovery would vary widely across countries.

In the status quo, a large amount of monetary, liquidity and fiscal policy support has been mobilised in response to the pandemic outbreak of the novel coronavirus, which seems to be working so far for the global financial markets.

To Know More, Do Read: Central Banks Draw Rate Cut Card to Spur Demand as World Grapples COVID-19, Commodities to Shine?

However, while the financial market across the globe seems to be recovering it is still uncertain whether traditional monetary and fiscal stimulus policies will have below-average or above-average multiplier effects, and a lower multiplier could result from depressed consumer and business confidence due to the deleterious impact of COVID19 on both jobs and profitability; and,

  • While a higher multiplier could occur if the lagged impact of the stimulus coincides with the release of pent-up demand as economies wake from hibernation, with the important caveat that major second waves are averted.

China Ready To Grease The Global Economic Wheel?

While the major steelmakers such as the United States, Europe, and India under full shutdowns or curtailments during the June 2020 quarter, China blast furnace utilisation rates have been increasing from around 73 per cent earlier in the year to almost 79 per cent in April, so far.

As per a report from BHP, daily rebar transactions across China are now at or above normal seasonal levels, while downstream activity improves. But, the risk remains, for example, while China only exports ~ 10 per cent of apparent domestic steel demand, the depth of the weakness in global demand could considerably weigh on Chinese flat products manufacturers, and if China can contain the risk of a second wave of infection the steel production might rise slightly in 2020.

So far, iron ore prices seem to be resilient over the supply woes and solid Chinese pig iron production on a year-to-date basis, which remained 1.7 per cent up against the previous corresponding period.

To Know More, Do Read: Iron ore Price Surge an Anomaly or a Fundamental Shift?

In its latest report, Rio Tinto also mentioned that the demand in China continues to recover, while for the rest of the world, it is yet to become clear how the demand would respond in the wake of ongoing lockdowns and halted economic activities.

In a nutshell, the confidence of ASX-listed iron ore miners on China seems to be well rooted; however, there are considerable risks, especially the risk of a second wave, are still intact, and while the March 2020 figures have shown some ray of hope, the overall trend in economic activities in China and across the globe is yet slow, which might or might not recover ahead, depending upon various policies, which governments could adopt to overcome these unprecedented and hard times.

Thus, a prudent action and astute judgement is a must in these times, and investors should consider and factor-in all possibilities to gauge through the dark cloud of these unusual times.

Also Read: Oil Crisis: Should you Buy or Sell Some OilStocks?



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