Although share markets in the developed world have recovered in recent days (see Chart below), the falls that occurred in the previous few weeks all have a single point of origin: China!

Source: Bloomberg Markets

The first reason for this is the Government mandated reduction in steel production. This flows on to to a reduced demand for iron ore, which, in turn results in lower share prices for Australian mining companies. As mining companies such as BHP, Rio and Fortescue, are such dominant parts of the ASX Top 20, any downward movement in their share price has a significant impact on the overall market. As shown in the chart below iron ore prices has fallen from the dizzying heights of $293/to back in July to $120/ton at the time of writing. However, don’t stress too much about Australian miners. Their cost of production, including shipping to China, is about $25/ton, so they’re still enormously profitable. They’ve just been enjoying super profits while Chinese demand remained high and their other supplier, Brazil, struggled due to the pandemic affecting their output.


So why is China mandating a reduction in steel production? The first reason is vanity. Beijing is holding the Winter Olympics next February and just as they did in 2008, they’re desperate to put on a show of clear blue skies. Given this is a passing moment, we should see some uptick in steel production, and hence iron ore demand, post Olympics.

The second reason is more structural and therefore more long lasting. China’s government is keen to reduce the debt fuelled oversupply of housing and infrastructure (you may have seen recent footage of unfinished apartment towers being demolished in spectacular fashion). One way of achieving this is through restrictions on the supply of raw materials like iron ore.

The other is by imposing restrictions on the availability of credit and this has precipitated the other big news coming out of China, which is the potential collapse of Evergrande, one of China’s largest property developers. The headline news is that Evergrande may collapse, owing the equivalent of USD300bn!. An extraordinary amount of money.

The fear is that could a debt default of that magnitude flow through to financial markets around the world (sometimes referred to as financial “contagion”). Here’s where context comes in. Evergrande’s liabilities represent about 2% of the total assets and liabilities of Chinese real estate firms. Furthermore, most of this debt is internal Chinese debt, only about $20bn is in US debt.

Given that the issue was engineered by the Chinese Central Government, it’s unlikely that it would want its interventions to result in an unseemly rapid collapse of Evergrande and that it will therefore take some action to prevent this happening. Some evidence of this happening has emerged in recent days with announcements from Evergrande that it has secured financing to pay (at least some) of its short-term debts.

The other point to make here is that we’re unaware of any western fund manager investing directly in the Chinese property market. Western investment exposure is mainly confined to the tech/consumer sector (Ali Baba, Tencent, So you’re unlikely to see any dramatic impact on your portfolios.

One positive note to end on is that the falling iron ore price has resulted in falls in the value of the Aussie dollar. It had been stubbornly trading in the USD75c range for many months but is now around the 72-73c mark and may fall a bit further. This makes other Australian export industries much more competitive and should therefore be a boost to our overall economy.