The Overnight Report: Iron Tanks

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By Greg Peel

The Dow closed down 34 points or 0.2% while the S&P fell one point to 1877 and the Nasdaq rose 0.1%.

It was an unusual but unsurprising session on Bridge Street yesterday. The materials sector fell 4% while no other sector moved more than 1% and five of ten sectors rose. Material stocks were hammered on the back of falls in iron ore and base metal prices, particularly copper, on Friday which occurred even before Beijing released data on the weekend showing an 18% fall in Chinese exports last month.

The 18% fall is somewhat of a shock, although there are some extenuating circumstances. The 11% rise in exports in January also took analysts by surprise, given the typical seasonal weakness of the month. This quickly brings into focus the annual lunar year holiday effect, and I don’t recall a start to a year for some time when Jan-Feb-March Chinese data have not caused a lot of wailing and gnashing of teeth at the time only to be dismissed as distortions down the track. Mind you, 18% is quite significant.

So perhaps what we’re seeing is the impact of Beijing’s attempts to weed out misleading reporting practices. Over-invoicing is one such practice which has the effect of inflating export numbers, and rarely do the import numbers of the corresponding trading partner correlate with the Chinese data. If suddenly the bookkeeping tricks have been stamped on, then perhaps that’s apparent in the sudden plunge in the numbers. This would mean future numbers are more reliable, but no doubt less spectacular on the upside.

Underlying all of the above, China’s economy has likely slowed. Perhaps not as sharply as the export numbers might imply, and indeed exports to the US and Europe in February were not down heavily, rather exports to Asian neighbours. And these are the numbers that never correlate.

Whatever the case, Wall Street didn’t like it from the bell last night, and we can throw in the revision of Japan’s December quarter GDP result to 0.7% growth from 1.0% as well. The Dow was down 118 points around 11am, but in the spirit of a true bull market the buyers moved in and pushed the indices back up once more. By the closing bell, the S&P 500 had fallen a point, having risen by point on Friday.

Weakness in the Dow last night was due mostly to Boeing, maker of the 777 that still has not been found.

Having risen firmly back above the 90 level on strong local data and the diminishing chance of another RBA rate cut, the Aussie has felt the reverberations of the Chinese data in falling half a cent to US$0.9019 since Saturday morning. The US dollar index was steady last night at 79.73, as was gold at US$1340.10/oz, and the US ten-year bond yield is little changed at 2.78%.

Base metal markets attempted to find some stability in London last night despite not yet having responded to the weekend’s China data, with nickel in particular rebounding 1.5%. But copper was down another 1.5% on concerns over the extensive practice of copper-backed borrowing as another Chinese “shadow bank” sideline and the possibility of inventory dumping continue to grow. The big move last night, nevertheless, was in iron ore.

Spot iron ore fell a whopping 8%, down US$9.50 to US$104.70/t. Analysts have been suggesting for some time that iron ore would not be hit by another destocking flood this year as was the case in 2012, at which time the price fell below US$80/t and briefly sent many an Australian producer into negative cashflow, including Fortescue Metals ((FMG)). Analysts have, on the other hand, long suggested that US$100/t was closer to the equilibrium point that might be reached in time, although US$120/t has been seen in the nearer term as reasonable.

Is iron ore again being rapidly destocked? Not only were the Chinese export numbers a shock but Beijing’s possible clampdown on spurious bookkeeping and a strengthening of resolve to shut down excess capacity in various heavy polluting industries might just be the triggers analysts had not expected. We can now only hold our breath, although it might be a good time to look at BHP Billiton ((BHP)) and Rio Tinto ((RIO)) as yield plays (see story today).

Energy markets also responded to the China data last night, with Brent down US84c to US$107.95/bbl and West Texas down US$1.47 to US$101.11/bbl.

The SPI Overnight has rather optimistically closed up one point.

There will be carnage among the iron ore pure-plays today.

NAB will release its monthly business confidence survey today while OrotonGroup ((ORL)) will release its interim result.
 

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