China’s Iron Ore Demand Boosts Australia’s Exports

By Ari Charney • November 8, 2013 • Pacific Digest

Our article last month about the surprising strength of Australia’s exports proved prescient, at least as far as the latest trade data show. Australia’s September trade deficit narrowed considerably, declining to a seasonally adjusted AUD284 million from a revised AUD693 million the prior month.

And that was a far better performance than what economists had predicted. According to a Bloomberg survey of 24 economists, the consensus forecast was for a deficit of AUD500 million. The August figure was itself a noteworthy improvement from the AUD815 million that was first reported.

Australia tends to run persistent trade deficits, which have averaged AUD367 million over the past five years, despite the fact that this period includes the nearly two years of trade surpluses posted during the resource boom. In fact, the September number was one of the best since late 2011. Of course, that’s just one month of trade data, but we’ll take it.

Credit for this performance is partly due to China’s demand for resources, particularly iron ore, which happens to be Australia’s single biggest export. According to government data, the total value of the country’s iron ore exports set a record high of AUD8.1 billion, the third consecutive month in which a new all-time high has been achieved. And China was responsible for the majority of this demand.

On a year-over-year basis, China is one of Australia’s only major trading partners whose demand for the country’s goods has actually increased. It’s up 1.6 percent over that period, which may not seem like much, except for the fact that China is Australia’s largest trading partner and is responsible for over 31 percent of the country’s total export value. In other words, China has been a stabilizing source of export demand amid an otherwise anemic global economy.

According to economists with HSBC, a rise in Chinese infrastructure spending accounts for much of this demand. That’s helped boost iron ore prices during the third quarter, a period during which prices typically weaken. Pricing data aggregated by The Steel Index Ltd show spot prices that prevail in China are currently near USD135.90 per dry ton, up 23.1 percent since the trailing-year low in May.

The good news is that analysts expect this trend to continue at least through year-end. The latest data from Australia’s Port Hedland, the largest bulk terminal in the world, suggest that iron ore exports may have sustained their record-setting pace through October. Iron ore exports that shipped from the port to China jumped 10 percent last month, to 25.2 million metric tons.

Economists expect China’s investment in infrastructure will slow next year, with some predicting that could cause iron ore prices to fall as low as USD115 per tonne. However, that could be partially offset by rising volumes as new mining projects come on line.

Even though investment in Australia’s mining sector has peaked, many of these projects are about to enter their production phase. Fortunately, Morgan Stanley analysts believe the global seaborne market will remain in deficit well into next year, and that should help absorb all the new production.

Currency depreciation should also prove helpful. The Australian dollar currently trades near USD0.94, down about 11.3 percent from its year-to-date high in early January. And the Reserve Bank of Australia (RBA) could help push it even lower with another round of rate cuts.

Although the RBA’s cash rate is at an all-time low of 2.5 percent, economists expect at least one more rate cut early next year. In the central bank’s latest statement on monetary policy, Governor Glenn Stevens characterized the Aussie as “uncomfortably high,” with further depreciation necessary to achieve economic growth.

Additional weakness in the currency will help make Australia’s exports more competitive globally, which should be a boon for our resource investments.

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Our analyses of Portfolio companies’ recent earnings reports are linked below.

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