Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn


Iron ore training wheels loosen for Australian equities

Nicola Chand  |  23 May 2022Text size  Decrease  Increase  |  
Email to Friend

Australia’s heavyweight mining sector is off recent highs as China’s severe zero-covid policy curbs demand for iron ore in the world’s largest commodity importer.

Iron ore prices are down 17.4% from their high of US$162 in early April as China doubles down on its controversial zero-covid policy amid signs of decelerating economic growth.

Activity in the resource intensive manufacturing and residential property sectors has slumped as tens of millions of citizens in the Chinese industrial hub of Shanghai enter their 7th week in lockdown.

Chief economist at AMP Capital, Shane Oliver says Chinese lockdowns are weighing on demand for iron ore at a moment when the global economy is already showing signs of slowing.

“There is this broader backdrop of concerns about a slowing global economy leading to less commodity demand,” he says, citing higher inflation and rising interest rates.

“We've seen clear indications the Chinese economy has slowed down quite substantially and may even be going backwards so far this quarter because of the COVID related lockdowns in various cities,” he says.

Robust commodity prices, iron ore among them, have helped shield the Australian equity market from the worst of this year’s rout in global markets. The S&P/ASX 200 Resources index was up 17% in mid-April, compared to a 7% decline for the US broad market S&P 500 over the same period.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

Weighed by the drop off in iron ore prices, the S&P/ASX 200 Resources index is 9.8% off its April high. A rally over the past two weeks pared losses back from 15%.

Commodity stocks are jittery as evidence grows China’s severe lockdowns are beginning to drag on growth. After growing 4.8% year on year in the first quarter, economic activity slowed sharply in April. Retail and factory activity fell by 11.1% and 2.9%, respectively year-on-year. Analysts expected a 1.6% decline in retail activity.

Morningstar chief economist Preston Caldwell believes the first quarter figures may have been overstated and is bearish in the short term. He slashed the year forecast for GDP growth to 3.2% from 4%.

“A dip into recession remains a significant risk, given the headwinds of omicron and an emerging trade slowdown,” he says.

Iron ore demand is also grappling with a broad slowdown in the resident property sector, which accounts for approximately 35-40% of China’s steel consumption, as the sector reels from government crackdowns and debt defaults.

Australian mining stocks are sensitive to the ebbs and flows in China’s economy. Moves by the government to cut emissions last year saw steel making activity and iron ore prices collapse between August and November. BHP, Fortescue Metals and Rio Tinto all fell 30% or more over the same period.

Weakness in commodity stocks can weigh on the wider index as the basic materials sector makes up almost a quarter of the S&P/ASX 200’s market capitalisation.

Morningstar mining analyst Jon Mills says China consumes such a large proportion of global iron ore, that small changes in the Chinese economy have big ramifications for prices.

“What happens if China goes into recession? It's going to impact demand for commodities. Again, China is the biggest purchaser of pretty much every commodity,” he says.

As lockdowns lift, iron ore should too

Mills believes the dip in iron ore prices is likely to be short lived. Lockdowns are probably unsustainable longer term and he believes the government will succumb to the temptation to stimulate the economy with commodity-intensive investment.

“I don't think that's [lockdowns] really a problem because it's a short-term thing,” he said. “In the long term, they’ll just do what they’ve always done, which is ramp up infrastructure spending,” he says.

Iron prices rebounded on Friday after the Chinese central bank slashed the five-year main mortgage rate for the second time this year, following a first cut in January. The 15-basis point reduction is the largest cut on record.

President Xi Jinping committed in April to boosting infrastructure spending in a bid to bolster the slowing economy. The move may signal a return to a familiar playbook for Chinese officials: growth driven by commodity-intensive investments in bridges, rail, roads, and other public works.

Oliver believes the government will either have to abandon the zero-covid policy or roll out additional stimulus measures.

“Steel demand hasn't collapsed yet and given the growth slowdown you could maybe argue that it should have fallen further. The reason it hasn't, is because the Chinese authorities are continuing to talk more stimulus. And so, there's that at the back of traders’ minds,” he says.

is a wealth and finance journalist with Morningstar

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend