The General And The Particular

Includes: BHP, RIO, VALE
by: Paulo Santos

More than often, when confronted with the theory that China's residential construction market will see reduced activity, the first thing those who disagree say is "China has a lot of room to stimulate". And yes, it really does have a lot of room.

But the problem is, while monetary and fiscal stimulation can indeed have an impact on the general economy, it won't necessarily change the dynamics of a particular sector all that much. Not if those dynamics are so powerful that to change them, you'd need to overheat the entire economy. That's the reason why although I too believe China has a lot of room to stimulate the economy, I still advance the theory that residential construction is in an unavoidable path towards reduced activity, and thus iron ore, steel, cement, copper, glass and many other construction materials are bound to suffer no matter what.

Again today we got news from China which showed how the iron ore and steel sectors are already feeling the investment slowdown. This came in the form of imports below expectations, and within these, iron ore imports dropping 9.1% year-on-year and steel product imports declining 20% year-on-year.

These drops aren't yet motivated by the slowing of construction. Here, auto production must have had the largest impact. Auto production, though, can easily recover, whereas the impact from reduced residential construction will be protracted, lasting 1-2 years.

Autos and consumption in general, are examples of sectors which will benefit from looser monetary and fiscal policies. Also, predictably enough while iron and steel are already suffering, crude still posted a 26% increase in imports. This expected difference in behavior is something I had already called the attention to in my article "There's More To China's Slowdown".


The conclusion remains that the main producers into the iron ore market, BHP Billiton (BHP) (around 50% of BHP's EBIT is from iron ore); Rio Tinto (RIO) (70% of RIO's EBITDA is from iron ore) and Vale S.A. (VALE) (derives 72.5% of its revenues from iron ore) will be hit by the reduced activity in China's residential and commercial real estate market. This will happen even with China implementing future monetary and fiscal policies designed to foster growth, namely further reserve requirement reductions and even interest rate cuts.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.