Chinese Steel Flashes Red for Rio

Steel prices in China have been dropping sharply in recent days, a bearish short-term indicator for iron ore prices and the world’s largest diversified miners, including Rio Tinto and BHP Billiton.

Two innocuous sounding corners of China’s titanic steel industry are sending bright red flashing signals. Export prices for so-called cold rolled coil (steel that is heated to extreme temperatures but finished off in cooling rooms) are sitting at record lows of around $300 per tonne, whilst hot-dip galvanised coil prices (steel that is coated in zinc) are sitting at their lowest level for 8 years.

Chinese steel mills are reportedly slashing prices to boost their sales figures before the end of the year, whilst buyers are sitting on their hands, expecting further falls. The country’s steel industry is the world’s largest buyer of iron ore, such that Chinese steel prices have historically been a brilliant leading indicator for the price of iron ore.

Borrowed Time

In June for example, we highlighted that the price of Chinese rebar (a type of reinforced steel) had sunk towards 12-year lows, even as the iron ore price rallied, a rally that was “living on borrowed time” according to Goldman Sachs. True to form, iron ore prices then promptly fell in line, plummeting by 25 per cent in 18 trading days by the beginning of July.

Fresh weakness in Chinese steel is therefore a grim indicator for the short-term outlook for shares in Rio Tinto, which relies on iron ore for more than two thirds of its profit. BHP Billiton, the world’s largest diversified miner, similarly relies on iron ore for 33 per cent of its revenue and 58 per cent of its profit.

Global Closures

China’s steel industry has been in the spotlight for UK investors in recent weeks, after a wave of steel plant closures in the seaside town of Redcar. India’s Tata Steel and Thailand’s SSI have both announced closures and thousands of job losses, unable to compete with a flood of Chinese imports.

Embarrassingly, the closures coincided with a diplomatic visit to Britain by China’s president, Xi Jinping. To avoid dumping on other countries, Xi Jinping conceded the need for China’s steel industry to tackle its over-capacity, whilst steel bosses in China said production needs to be cut by as much as 20 per cent.

Wide of the Mark

According to some estimates, the country’s steel industry is currently lossmaking to the tune of $350 million per month, or $4.2 billion per annum, figures that leave bullish forecasts by Rio and BHP looking increasingly wide of the mark. “The customer is ill,” wrote analysts at Investec this week, “has lost his appetite and seems unlikely to recover anytime soon.”

Rio Tinto last traded at £23.90, up 13 per cent since touching a 6-year low in late September, whilst BHP Billiton is trading at £10.76.