By Chris Oliver, MarketWatch
HONG KONG (MarketWatch) -- Australian iron-ore miners and their global peers could soon find China's property market to be an unexpectedly large factor in their short-term fortunes, analysts say.
The problem lies in the miners' new ore-pricing model.
The revamped system, supported by mining giants BHP Billiton Ltd. and Rio Tinto PLC, shifts the pricing of iron-ore contracts towards quarterly averages in the spot market, or in some cases, monthly averages.
The new pricing scheme replaces the annual-price benchmarking system, begun in the 1960s and used more or less universally up until March -- a process, typified by long negotiations, in which miners and their steel-mill clients set a single price for an annual contract. The new system was seen as a benefit to miners in the short term, so long as commodities continued to rise.
The problem for BHP, Rio Tinto and others, is that the system has the opposite effect on their revenue during commodity downturns, and more generally, exposes them to unexpected shocks of the kind that some analysts believe are now brewing in China's housing market.
"I am quite bearish on base-metal resource stocks, since the implied prices of their commodities are not demonstrating any realistic view of the future slowdown in China property prices," said Nomura International strategist Sean Darby in Hong Kong.
Darby warned in April of a "perfect storm" striking the Chinese real-estate sector, as government efforts to cool the market were likely to coincide with dwindling sales volumes and increasing supply.
In a research note earlier this month, he said the growing disparity between property prices and a share-price index of real-estate developers, which have moved in opposite directions since October, foreshadow a downturn.
So far, however, commodity markets have mostly shrugged off concerns surrounding China's housing market, as investors look instead to that nation's accelerating economic growth rate. A gauge of daily iron-ore spot prices at Chinese ports, known as the Steel Index, surged to a record $186.50 per dry metric ton on April 21, trading at an average level 25% above those in March.
Danger signs
However, the first cracks in China's property could be emerging, according to according to unofficial figures released Friday by researchers at Standard Chartered.
Prices for new homes in Shanghai dropped 28% week-on-week at the start of May, while Shenzhen saw a 26% drop, and Beijing prices lost 11% in the four weeks leading ending at the same period, according to data compiled by the bank's China office.
Standard Chartered cautioned that the figures were an average of luxury and mid-market transactions, and subject to potential distortions.
Price declines in other major cities have been milder, though the volume of sales are still off by nearly a quarter in "second-tier" cities such as Chongqing, indicating that some buyers and sellers are taking a wait-and-see approach.
"Even given the recent declines, prices have a lot more room to fall," Standard Chartered analyst Jinny Yan wrote in a research note released Friday.
In pushing for the new spot-market pricing, Anglo-Australian miners BHP Billiton and Rio Tinto , along with rivals such as Brazil's Vale SA , may have been blinded by talk of a long-running "commodity super cycle" bull market, along with an overly-rosy view of China's ability to sustain double-digit annual economic growth, analysts said.
The spot-market pricing push was "based on the extremely low-IQ assumption that the spot price will always move up," said David Roche, an economic and political analyst who manages the Hong Kong-based hedge fund Independent Strategy.
Roche believes China is in the early stages of a credit-bubble collapse that will knock back its annual growth rate to around 6%. See full story on Roche's views on Chinese growth.
Roche said he doesn't own any natural-resource stocks, adhering to the view that easing demand from China -- whose imports account for 70% of the global maritime iron-ore trade -- will eventually put downward pressure on all industrial commodity prices, with the possible exception of crude oil.
Under this scenario, iron-ore prices could fall to half their current levels within a single quarter, Roche said, adding that the credit implosion would also impair the ability of Chinese local-government financing vehicles to fund infrastructure works.
Mining firms, though, appeared confident for now, with BHP Chief Executive Office Marius Kloppers saying he expected iron-ore to remain supported near $120-$130 a ton, even if China's economic growth slows.
"That's the marginal cost of supply, and at that level it's very buffered," Kloppers was quoted as saying Friday. See full story on BHP Billiton CEO's price forecast.
Not all buyers of iron ore are happy about the new system. Talks to establish a fixed system between the major miners, and a group representing top Chinese steel mills have dragged on for more than a year, with the mills reportedly forced to use quarterly averages in the interim.
Ironically, the Chinese steel firms have led opposition to the spot-pricing system, but could wind up as beneficiaries if ore prices fall significantly and BHP, Rio and Vale are forced to accept much less payment than they would have received under the old system.
At least one major player on the steel side may be having a change of heart: Baoshan Iron & Steel Co., China's largest listed steel producer, told Chinese state media earlier this month it was studying a switch to the new pricing system.
Meanwhile, Chinese property developers facing tighter restrictions on bank credit and other fundraising activities are likely to shelve or postpone new projects, putting the brakes on China's construction boom -- and demand for steel, copper and other materials.
"I would not own resource companies, and I would short physical copper," Roche said.
Nomura's Darby said a slowdown in China couldn't come at a worse time for Australian miners. The Australian government is planning to revamp its taxation system, with a 40% resource "super profits" tax set to begin in July 2012. This, Darby said, could amount to a "double whammy" when ore contracts eventually reset at lower spot prices.
Still, the new resource-tax scheme has drawn sharp criticism from the top mining firms, who would likely see the largest hit from the new national levy, and some analysts who say the plan could undergo significant changes or be scrapped completely.
Chris Oliver is MarketWatch's Asia bureau chief, based in Hong Kong.
Sourced from www.marketwatch.com
