Australian commodities at risk in Evergrande turmoil: Charts of the week
The Chinese real estate sector is a significant driver of global commodity demand.
Global markets may have brushed off early-fears the Evergrande demise would spark a global financial crisis, but concerns remain about what China's property slowdown could mean for commodity producers.
After a global sell-off Monday, the US Dow Jones index rallied 2.5% on Wednesday and Thursday, its biggest two-day gain since March. Hong Kong’s Hang Seng Index, where Evergrande is listed, ended the week 1.2% up from its Tuesday low.
Evergrande is one of several highly indebted real estate developers the Chinese government has tried to reign in for several years. Others include Guangzhou R&F Properties and Kaisa Group. The government is concerned about the risk China’s real estate boom poses to financial stability and has been cracking down debt levels. Last August’s “three red lines” policy limited borrowing for highly indebted developers and helped trigger last week’s liquidity crisis at Evergrande.
MORE ON THIS TOPIC: The Evergrande crisis explained: Should Australian investors worry?
If it succeeds, it could translate into falling property prices and a slower pace of construction, says Yixiao Zhou, an economist at the Australian National University.
“China is the only major economy trying to control rising house prices with strong policies,” she says.
The impacts of regulatory tightening are beginning to show. China’s home sales by value slumped 20% in August from a year earlier, according to Bloomberg calculations based on National Bureau of Statistics data released Wednesday.
That matters because the real estate sector in China consumes vast quantities of raw materials. Anywhere between 5% and 20% of global commodity supply, according to a note from Tom Price at broker Liberum. A reduction in demand could quickly flow through to major commodity producers worldwide.
In today’s Charts of the week, we look at Chinese real estate’s contribution to the global commodity trade and what it means for major commodity producing nations.
China’s construction boom
China’s construction boom—both real estate and infrastructure—is unprecedented in global history. Between 2015 and 2017 China produced more concrete than the US did between 1900 and 2017—a period that featured two world wars and the paving of a national highway system.
Concrete is not poured into apartment shaped molds alone. It is reinforced with steel. It is strung with copper. A whole ecosystem of metals is required to make making buildings habitable. A slowdown in residential construction impacts this whole ecosystem.
Price estimates 20% of global steel is used in Chinese real estate. That steel is made with Australian iron ore and coking coal.
For miners like BHP (ASX: BHP) and Rio Tinto (ASX: RIO), this ecosystem of metals underpins a massive chunk of earnings.
Between 65% and 75% of BHP and Rio Tinto’s earnings come from iron ore. That rises to more than 90% once metals such as coal, copper and aluminium are included. These are all metals that have been supported by a booming Chinese real estate sector.
Morningstar director of equity research Mat Hodge says a collapse at Evergrande could hurt the iron ore miners before flowing through to less tax revenue and a worsening trade balance.
“It could be a significant turning point for the iron ore miners in particular, and potentially for Australia too,” he says.
Iron ore prices have almost halved since August, as China separately tries to cut output in the steel sector.
Investors holding the companies will feel the sting most directly if Chinese demand slows. But the weight of mining on the S&P/ASX 200 means any pain will also be distributed to index-tracking fund holders.
Both Rio Tinto and BHP are down more than 10% on a 1-month basis. Hodge doesn’t see any bargains among the big miners yet but advises investors to watch the space in case they are oversold.
Is there a trend you'd like to see visualised? Get in touch.