Iron ore prices set to fall?

Australia and New Zealand Banking Group said China could ask Cia Vale do Rio Doce, Rio Tinto and BHP Billiton and other iron ore suppliers to cut prices by 50 percent. This was because the fall in steel prices was not felt in the iron ore prices, one of the main raw materials used for the production of steel, besides coke. As reported here earlier, China has been very upset with the Rio Tinto and BHP Billiton miners ever since both companies practice double standards in selling to them and to Europe. The latter which accounts to less than 3% of the said companies' sales revenue were sold at a much lower price than China's which accounted to nearly 50% of their sales. Will China be able to turn the table around this time to force the bullies to cut their iron ore prices or face the consequences of a potential standoff? Stay tuned!

XFN-ASIA: China said iron ore prices should more closely track the decline in steel prices, the official Xinhua news agency reported, citing Shan Shanghua, secretary-general of the China Iron and Steel Association.

"Iron ore prices should be consistent with steel prices, which have fallen to the 1994 level. We will require Rio Tinto and other suppliers to cut prices sharply," Shan said. Benchmark contract iron ore fines sold by Rio Tinto are at around 92.58 usd per ton currently. In 1994 the price was 16.69, implying a decline of up to 82 pct if current prices are made to mirror that year's levels exactly.

* Bloomberg: Rio Tinto to slash 14,000 jobs and cut USD5b in spending.

* Malaysia frees 911 suspect.

* Markets in Asia continue to climb....towards 2008's year end window dressing?

* Bloomberg: Democrats, White House agree on the US15B US automakers bailout plan. Congress may vote today.

* The Standard: After proposing a 5T Yen extra spending plan in September, Japan is reported to be considering up to 20T Yen in new stimulus spending to avoid a long and painful recession.

* Interest rate for short term US T Bills has turned negative.

Happy Franksgiving!

According to Wikipedia, thanksgiving is a harvest festival. Traditionally, it is a time to give thanks for the harvest and express gratitude in general. It is primarily a North American holiday which has generally become a national secular holiday with religious origins. Here is an interesting article about thanksgiving, or rather franksgiving and its relevance to the era of Great Depression. Why you may ask? Kindly read on......

Franksgiving - one more lesson from the Great Depression

Faced with the scale of the current financial crisis, many economists have turned to the Great Depression to look for policy lessons. Tyler Cowen, a professor at George Mason University, shared his thoughts on the topic recently in the New York Times. His take? The New Deal Didn't Always Work, Either. Faced with an unprecedented crisis, Roosevelt experimented with a mix of policies, and some worked and some did not.

Here's one of the (now long-forgotten) policies that did not work: Franksgiving. Nowadays, the U.S. celebrates the holiday of Thanksgiving on the fourth Thursday of November. It wasn't always that way, though. Traditionally, Americans celebrated Thanksgiving on the last Thursday of November. Every few years, there are five Thursdays in the month of November, and 1939 was one of those years. Unfortunately for retailers, this meant that the Christmas shopping season would be very short.

Enter Lew Hahn, general manager of the National Retail Dry Goods Association. He suggested that the date of Thanksgiving be moved forward to help boost retail sales. In late October 1939, Roosevelt announced that Thanksgiving would be on November 23 rather than November 30. National outcry ensued, and Thanksgiving was christened with the name Franksgiving (after Roosevelt's first name). Alf Landon, Roosevelt's opponent in the preceding election, compared Roosevelt's actions to Hitler's:

"If the change has any merit at all, more time should have been taken working it out... instead of springing it upon an unprepared country with the omnipotence of a Hitler."

The result? At least according to Wikipedia(no citation is given), the Commerce Department found no significant expansion of retail sales. The only lasting consequence is that Congress eventually changed the law to establish the fourth Thursday of November as Thanksgiving. This year Thanksgiving falls on the 27th, so Americans will have just under four weeks for holiday shopping. Perhaps it won't be enough to revive the global economy, but it's better than only three weeks.

By Ryan Hann (http://psdblog.worldbank.org/psdblog/2008/11/franksgiving--.html)

* Violence brewing in Asia- India and Thailand.

* Financial markets seem to be on the rise again? Defying the gloomy economic pictures and technical charts....

* FT.com: The cost of shipping dry bulk commodities such as iron ore, coal and grains plunged to a near 22 year low on Wednesday. The Baltic Dry Index fell 5.1% to 762, lowest since January 1987. The index has tumbled 93.5% from all time high of 11,793 points in May.

*TheStar: Local steel makers are making provisions for their inventories following sharp decline in prices of raw materials and finished products. Perwaja wrote off RM120.2m while Choo Bee RM22.3m.

* Bloomberg: The People's Bank of China yesterday cut its 1 year lending rate by 108 basis points to 5.58%. Slow growth is worrisome in China.

* Bloomberg: China's foreign reserves now top US2T!

Technical Analysis - August 04 2008

S&P500 (1,260, last week 1,258 or +0.16% w.o.w)

The daily charts; especially the MACD continues to improve during last week albeit slower. The daily DMI(+ and -) has not shown any positive crossover yet and in fact they move further apart. The weekly charts although improved are still a long way off from a positive uptrend. The index is likely to trade between 1,232 and 1,330. Major resistance is seen at 1,280 as it tries to stay above the newly created 2nd level uptrend channel line. (refer charts above)

KLSE CI (1,159, last week 1,142 or +1.5% w.ow)

The daily MACD continues to remain on the uptrend and the DMI (+ and -) has just turned positive yet. The daily stochastic indicator shows that it may have a technical correction in this week. The weekly charts have shown some improvement but nothing concrete just yet.The index is expected to trade between 1,120 and 1,190. Strong support is seen at 1,142.

HangSeng (22,863, last week 22,741 or +0.5% w.o.w )

The daily charts especially the MACD continues to improve while the daily DMI (+ and -) has also shown a slight mix of positive/negative crossover during last week (indicating a very volatile week). The weekly indicators have not turned positive yet but it have since shown a slight hook up and improving. Immediate support is at 21,900 while resistance at 23,500.

Nikkei 225 (13,095, last week 13.335 or -1.8% w.ow)

The daily MACD chart is still positive albeit weaker while DMI(+ and -) did not maintain a positive crossover as they break away from each other during last week. As a result of the weakening daily indicators, the weekly MACD is now at the crucial stage of hooking down. The weekly MACD has been on a positive crossover since April this year. Short term players may be cautious this week and may leave the market if the daily indicators deteriorate further. The index is expected to trade between 12,500 to 14,000. 13,500 is a tough resistance to break but if it is broken, the chart will be on an uptrend again.

* CNBC: South Korea's foreign exchange reserve fell by a record amount in July as Authorities have sold about USD15b to prop up the won.(The reserves for July USD247.52b, June USD258.10b) South Korea's reserve is ranked 6th in the world after China, Japan, Russia, India and Taiwan.

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* Write-off No 1: Perwaja Holdings Bhd will write-off RM550m accumulated losses via capital reduction towards the year end by reducing its paid up capital from RM1.22b to RM787.78m. According to Perwaja's MD: "It is a cosmetic change. Potential investors can rest assured they are not buying into Perwaja's accumulated losses, the NTA is clean". Perwaja' shares will be listed on the 20th this month at and IPO price of RM2.90 per piece. According to Aseam Bankers(refer here), Perwaja's fair value is RM4.50! So good ah?

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* Write-off N0 2: TheEdge-Axis may have to write-off RM161m as auditors could not find enough evidence on the recoverability of amount owed by its contract manufactures and others mainly from Vietnam and Cambodia.

Revenge in the making?

No I am not talking about the current tit-for-tat between Anwar and Najib or Najib and RPK. It is about the rumoured revenge that the Chinese Government is going to take on the two giant Aussie miners for practising double standards. To me, China may have lost in this "negotiation"(also discussed here previously), but it has gained something precious in return. It's called "wisdom" which is a valuable lesson that can be useful in the future. One thing for sure, irregardless what happens between the iron ore miners and the Chinese producers, high steel prices are here to stay.

UOBKayHian:China is upset with BHP Billiton and Rio Tinto for their two tracked pricing policy of their overseas iron ore sales – a smaller increase for European mills and a substantially bigger one for Chinese mills. Now, Beijing is reportedly looking at a sharply higher export tax on coke to rein in coke exports, and ultimately, iron ore prices. China accounts for about 60% of the global seaborne trade for coke, so any cut in its exports will have an impact on global supply, and thus steel output, and – China hopes, ultimately on
iron ore prices.

China fuming

The Chinese are seriously upset with the giant Australian mining groups, BHP Billiton and Rio Tinto. Key Chinese industry and semi-official representatives in the steel industry are now exploring ways in which they can avenge the ”double standards” of the two mining giants. About 10 days ago, Australian newspapers reported that BHP and Rio Tinto have agreed to a 71% rise in the price of iron ores for European mills, which is significantly lower than the 96.5% they extracted from the Chinese mills for lump ores, and 79.9% for fine ores in June. The different pricing policy is especially galling to the Chinese because each of the two groups sells no more than 3% of their ores to Europe whereas China accounts for nearly 50% of the global seaborne trade in iron ores, and are thus their biggest client. Just three players, BHP, Rio Tinto and CVRD supply 78% of the global seaborne trade in iron ores. Press reports suggested that BHP, planning a hostile takeover of Rio, was eager to show to the European regulators that it was a price taker, hoping to ease fears that any merger with Rio would lead to monopolistic pricing practices. Rio Tinto has also reportedly accepted this range of price increase for its European customers. Two options for China. What can the Chinese do? There are two options:

􀁺 Ban China's exports of coke, or

􀁺 Increase the export tax of coke by 5% to 30%

Option 1: Ban coke exports

This is the more radical of the two options. Coke (coking coal accounts for 93% of the COGS of coke) and iron ore account for about 50-60% of the COGS for a tonne of steel. As the table below shows, China is the world's largest exporter of seaborne coke, accounting for 61% of the global total last year. Any ban in exports would have some impact on the overseas steel
trade and, indirectly, on global iron ore trade. One could argue that retaining coke for domestic mills will encourage domestic steel expansion, and could pick up the slack in iron ore purchases abroad. But, China is currently cracking down on more coke and steel expansion. A tonne of steel uses between 0.5-0.6 tonne of coke. China's 15.3m tonnes of coke exports last year would thus affect about 28m tonnes of world crude steel output. Assuming an average iron content of 0.65 in iron ores, then a mill needs 1.5 tonnes of iron ores to produce a tonne of steel. With 28m tonnes of crude steel output, that will affect 42m tonnes of iron ore sales, which was 5% of global seaborne iron ore sales, or 11% of China's iron ore imports last year. This radical option can thus depress the price of iron ores somewhat and should hurt BHP and Rio Tinto more. The key buyers of China's coke exports are Japan (22% of China's overseas sales), Brazil (15%), Belgium (10%), US (10%), and India (6%). China has just set an export quota of 12.1m tonnes for coke this year, down just about 1% from last year.

Option 2: Raise export tax for coke

This is the more likely scenario. Given that China has been raising the export taxes on resource-based and polluting exports, we see a strong chance of it lifting the export tax on coke from the current 25% to 30%. This would reduce the incentive for coke exporters to sell overseas, which will still have an impact, considering that China is the biggest exporter in the world. But the impact will obviously be smaller than an outright ban.

Conclusion

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Will China again prove to be a paper tiger, allowing major mining giants to turn its great demand into a liability? This is a tempting conclusion as it proved time and again that it failed to get what it wants during the iron ore negotiations in the past few years. However, media reports suggest a simmering real anger at the Australian groups, so we believe that something will be done. Of the two options we outlined above, we believe the more likely short-term scenario is to raise the export duties to 30% for coke, and eventually to ban coke exports in two to three years.

* National Australia Bank, the nation's top lender, book another A830m(USD800m) losses from its exposure to US mortgages. Total provisions made todate is currently A1.01b.



* Reuters: China's securities regulator has ordered fund managers to refrain from making public comments about the Shanghai Stock Exchange Composite Index's loss of more than 50% of its value from its October 2007's peak.



* ChinaDaily: The Chinese government will further enforce the price controls on coal used for power generation, in a move to keep the prices in line and to ensure supplies for thermal power plants.

Steely as it goes

According to UOB KayHian, China may accept the 85% price hike for iron ore(includes a freight premium) from BHP Billiton and Rio Tonto for a 1 year contract. To recap, earlier this year, Asian steel mills and the Brazil-based CVRD agreed on a 65% increase in iron ore price for 2008. This topic was discussed earlier here. The acceptance was widely expected as China seems not to have enough of raw materials(ie iron ore/scrap metals) for its production of crude steel while the demand is ever increasing. As the biggest steel producer in the world with limited reserves, China imported over 383m tonnes of iron ore and concentrate in 2007. Most of the steel mills in China rely at least partially on overseas supply of iron. Steel mills face great pressure from rising raw material costs and but it is likely to pass the cost to the consumers at a much higher percentage of increase. The latest acceptance by China to buy at a higher iron ore price in addition to operating costs (i.e. thermal coal, coke, power tariff, etc.) will increase the millers' cost of production. Unless China's demand for steel reduces due to the slow down of its economy, steel prices would definitely on the rise again. The supply constraint and hugh demand within China and escallating raw material cost forced the Chinese Government to impose export duties on its semi-finished and finished goods (billets, bars, wire rods and pipes) in addition to its removal of the rebate on VAT for these products. China in curbing export and the growing need for steel products by other developing countries augurs well for the steel sector outside China. The strong prospect of steel sector is underpinned by rising international steel and steel product prices and strong steel demand locally and overseas egs Singapore's Intergrated Resorts, India and Middle East Countries. Amongst the steel companies in Malaysia, I would consider Ann Joo Resources Bhd and Kinsteel Bhd(with the spinoff from the listing of Perwaja this year) as the most complete intergrated player which have presence in the upstream, midstream and downstream segments. With efficient and larger production infrastructure already in place, they are ready to ride on this commodity boom. Ann Joo especially has a strong management team that has so far provided an excellent track record in effective inventory management and procurement strategies. Ann Joo has a P/E of 7X FY09 -eps 09 of 50sen while Kinsteel has a P/E of 7X FY09-eps 09 of 19 sen. The expected valuation of these companies may have to be revised again soon with the coming up of good quarter results. As noted, Ann Joo's latest 1Q09 y-o-y growth in net profit was 600% with a revenue of RM838m and net profit of RM96.3m.

* More than 60,000 people are believed to be dead or missing in a devastating cyclone that hit Myanmar on May 2. Interestingly in a study done on insurance claims by Swiss Re, last year itself, there were 149 natural and man made disasters(13,800 people dead/missing) in Asia with an insurance payout for property and business for USD3.5b. On the contrary, in Europe during the summer storm(1,088 people dead/missing) the insurance payout was USD12.43b. Are Asia's businesses and properties under insured? Pretty much so.

Overhang for Steel Stocks

UOB KayHian: The failure of Chinese steel mills to reach an agreement on the price for their 2008/2009 iron ore imports with the Australian ore suppliers – Rio Tinto and BHP BIlliton – will likely create an overhang for steel stocks dependent on imports until the talks are wrapped up.

Given the chasm between the two countries, an agreement is unlikely any time soon and could drag until June.The Chinese mills expect the two Australian suppliers to accept the 65% price rise that Brazil’s CVRC - had earlier agreed with the Chinese and Japanese steel mills about two weeks ago.

Australian mines want higher ore price rise. However, the Australian miners want much more – they want to equalise the price of ores imported from Brazil and Australia. In general, the port price of ores of similar grades imported from Australia is at least US$30/tonne cheaper than that of Brazilian imports because of the lower shipping cost arising from the shorter distance from Australia to China. The Australian miners want a share of the cost savings in freight and so are demanding ore price increases of well over 70% - or else one of them, Rio Tinto, has openly threatened to sell more of its ores on the spot market. Spot ores now fetch about US$210/tonne compared to the US$108/tonne that CVRD has agreed with the miners. (The new contract rates agreed with CVRD will be effective from Apr 08 to Mar 09, which ties in with Japan's new
fiscal year.)

Global ore trade are in hands of three miners. About 90% of the marginal increase in the global iron ore trade comes from China as its steel sector produces about one-third of the world’s steel output. Almost 80% of the world’s trade in seaborne iron ores are in the hands of three miners – CVRD, Rio Tinto and BHP Billiton - allowing them to extract huge increases for their ores. The Chinese are handicapped by a fragmented steel market, so it is hard to gain any leverage from being the world’s biggest importer of iron ores.

Higher China ore output not enough. China has been trying to raise its output of ores, but it is still not enough to meet demand. In general, they are low-grade ores of 35% iron content compared to the average grade of 65% for imported ores.

My Take: I believe the Chinese will have no choice but to subscribe to the Aussie's demand as the latter can sell the ores at a much higher price at the spot market and will be quickly taken up by international buyers. (The other main exporters of iron ore are India, Russia and Iraq but they are of lesser quality and output). The Chinese will buy because there is a sustainable demand in China for steel products. Furthermore, the fact that the 10 ten millers in China only has 33% market share in the country's steel industry compared to Japan's top five millers who have at least 70% of market share, only show Chinese millers have little leverage in negotiation of iron ore pricing. The increase in the primary cost of production(iron ore, coal and freight charges) by the millers will be passed on to the consumers but if the price is too high, consumers may take on the lower quality steel. Millers in China are pressured to have a modern, efficient and environmentally friendly blast furnace plant and they do not come cheap. This industry is facing massive challenges ahead.