The Iron Ore Bear Market

Last week was notable for the dramatic collapse in iron ore prices and the resultant impact on the share price of Aussie iron ore miners.

Today we will look at the recent data out of China and the impact slowing economic growth is likely to have on iron ore prices going forward.

China trade collapse

Data revealed the biggest monthly slide in Chinese exports since 2009, with overseas shipments crashing 18.1% year-on-year during February.

This compared to economist estimates for a 7.5% gain as well as a 10.6% increase in January. Imports soared 10.1%, in line with January's gain and occurred amid a surge in copper imports.

The slide in its exports saw China swing from a surplus of $31.9 billion in January to a deficit of $23 billion in February - China's second biggest deficit on record.

Beijing intensified efforts to curb suspicious capital inflows embedded into China's foreign trade via export over-invoicing. This shady practice likely inflated last year's export numbers.

Also, there was the likely effect of the Chinese Lunar New Year on trade activity.

Even after accounting for the distortionary effect of the Lunar New Year, Chinese export growth has been generally been heading downward for a number of years now, as weak global growth diminishes demand for the nation's shipments. This is illustrated below:

Manufacturing woes

HSBC's China Final PMI returned a reading of 48.5 for February, which although slightly higher than the Flash PMI of 48.3, still signalled China's manufacturing contraction worsened from the previous month.

The new orders and output sub indices swung to a decline for the first time since July 2013, signalling companies reduced purchasing activity in February. The employment sub index also fell at the fastest rate since March 2009.

The February PMI numbers were disappointing and offered further evidence that China's economy has entered a rough patch.

Beijing responded to the data by reaffirming China's GDP growth target of 7.5% for 2014, saying it would do whatever it takes to achieve this aim.

The policy response to the manufacturing slowdown is likely to be an increased focus on boosting jobs and targeted tax breaks to spur business investment.

However this will take time to play out, suggesting the manufacturing sector is unlikely to return to growth until later this year.

Iron ore sell-down

China's recent economic woes have helped drive a significant drop in the price of iron ore. Since August 2013, iron ore has sank more than 20% and is now technically in a bear market.

The following chart shows the China import Iron Ore Fines 62% FE spot price (red line) and Chinese iron ore stockpiles (white shaded line).

Source: Bloomberg

As can be seen, the iron ore price drop has coincided with a big spike in ore inventories at Chinese ports.

This is a very worrying sign as the last time stockpiles were this high iron ore plummeted to just $85 a tonne.

Part of the reason behind the inventory surge has been the tendency of Chinese steel mills to borrow money against stockpiles in trade finance deals.

However Beijing has begun cracking down on this practice, forcing the same steel mills to sell down inventories to repay their debt.

This will likely contribute to further short-term iron ore price weakness, particularly if weak Chinese economic growth prevents a recovery in steel demand.

Unfortunately, this suggests further medium term pain for Aussie iron ore miners.

Weekly Market Wrap: The Iron Ore Bear Market is a post from: Australian Stock Report Market Pulse Blog