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China economic outlook materials sector

April 2018

Trip notes - China materials: A view from the ground

Notes from our recent China tour as we assessed how recent developments have impacted the materials sector.

Much has been discussed about the developments in the Chinese materials market. Environmental regulations and winter season shutdowns have had a pronounced impact on Chinese materials supply and by extension on global pricing. The wide ranging implications of Chinese supply curtailment, and of course the evolution of Chinese demand, led us to plan a trip to the region to get a feel for what is actually going on in government offices, on production sites, and company meeting rooms.

What is certain is that the environmental changes are here to stay

For the sake of brevity, in this short blog post we’ll focus on steel and iron ore. At the risk of sounding like a central banker under journalist pressure, the overall impression was one of cautious optimism. What is certain is that the environmental changes are here to stay. Inefficient and polluting steel mills continue to be shut down and taken off the market. This puts a floor on steel mill margins as the government is clearly committed to delivering a reformed and profitable industry. With that said, a return to the buoyant margins seen during the second half of 2017 is unlikely as a key input, coking coal, is in short supply and will likely remain well bid. 

Separately, as for iron ore, pricing is likely to stay range bound but still at great levels for decent cashflow generation. In the short term, here it would seem risks are skewed to the downside. Inventory levels have piled up as Chinese market participants overestimated construction starts. As of yet, we do not see this as a concern. Many seasonal factors ranging from the recent National Communist Party Congress to a late Chinese New Year have had a temporary effect.

These sorts of trips provide us with snippets of information which are crucial to our bottom-up fundamental approach.