The iron ore price could fall in 2024 if China enters an entrenched economic slowdown and its property market continues to falter, potentially weighing on Australia’s biggest iron ore exporters BHP, Rio Tinto and Fortescue Metals Group, according to Income Asset Management’s chief investment officer, Craig Swanger.
Iron ore has been one of the most strongly performing commodities in 2023. In November, the price rallied to its highest close since June 2022,[1] though it has eased back in recent days on warnings from Beijing about increased market supervision as China seeks to curb price rises for the essential commodity.
Any further weakening in China’s economy, and the iron ore price, could weigh materially on Australia’s share market, and on iron ore miners in particular, given China is Australia’s largest export partner and iron ore the nation’s largest export.
“Australia is the most China-dependent country in the OECD. Iron ore exports to China now make up a whopping 36 per cent of Australia’s total exports while 69 per cent of China’s demand global iron ore imports relates to Australia and the largest component of this demand comes from China’s new home development. The two countries are highly dependent upon each other.
“China’s property sector has run too hot for too long and is now putting the entire growth story beyond the control of Beijing. China now faces a very real risk of having its own version of Japan’s ‘lost decade’. This has very significant implications for parts of the Australian economy and investment markets,” said Mr Swanger, who expects the iron ore price to fall back sharply in 2024.
“If China’s economy continues to slow, we could see a severe downturn in global commodity prices which would hurt Australia’s iron ore mining sector and the broader economy given the nation’s terms of trade are so closely linked to commodity prices,” he said.
According to Mr Swanger, iron ore has moved to being overpriced this year in the hope that China’s economic growth would gather pace, and with that, steel demand. However, he doesn’t think the high price is justified.
“While new sources of demand for steel, including that for electric cars could one day replace demand from the property sector, that forecast is based on hope, not investment fundamentals. So, unless a new growth engine is found quickly, an economic crisis is brewing in China and the property sector defaults seen recently are just the beginning of this crisis,” he said.
In this environment, he believes a shift in risks taken, rather than a reduction in risk, should be used as a hedge against the hard to measure risk of a China slowdown. A shift from equities to corporate bonds, or a shift from primarily iron ore exporters to exporters of other commodities such as coal, protein or other base metals, will reduce the China-specific risk while keeping total returns around the same levels.
“This growing economic uncertainty in China underscores the importance of shifting to more defensive assets and away from growth assets, including allocating to corporate bonds from equities and shifting allocations to higher quality bonds from lower quality bonds and to higher quality shares from lower quality shares.
“In terms of equity allocations, it is important for investors to be overweight companies in sectors that have a low correlation to the overall economy such as infrastructure assets, childcare and healthcare companies, and diversified financial services companies. Spending in these sectors is typically more non-discretionary than with cyclical companies including iron ore exporters, giving these companies greater resilience during an economic downturn” he said.
Mr Swanger believes any downturn in China’s residential property market will hit the consumer sector particularly hard. Residential property accounted for around 60 per cent of household wealth in China in 2020, compared to around 50 per cent in advanced economies.
“As consumer confidence is required for China’s growth prospects to be fully realised, any downturn in residential property values risks a GFC-like outcome for China,” he said.
