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China’s industrial output, crude steel and electricity outputs to be specific, are bellwethers of demand for raw material shipments. When industrial production rises at a fast pace, so does demand for raw materials, such as iron ore and coal, which is often accommodated by higher domestic production and imports. Since dry bulk ships take one to two years to construct, supply is quite inelastic. Thus, changes in imports have large impacts on shipping rates, and vice versa.
Industrial production misses, sending global markets down
On April 15th, the year-over-year change in industrial output fell from 9.9% in February to 8.9% in March, missing estimates of 10.1% compiled by Bloomberg. Crude steel and electricity outputs, the most important data that directly influences iron ore and coal imports (shown in the chart above), reported increases of just 6.6% and 2.1%, respectively, over the same period. In the past, electricity output has risen at 10% during periods of strong economic growth.
Gross domestic product (GDP), a measure of economic activity, also missed estimates of 8%, which came in at just 7.7% for the first quarter. The government has set 7.5% growth in GDP as this year’s target. Investors must grapple with the reality that China’s economic growth will unlikely surpass that of pre-2008 as the country shifts away from heavy investment driven economic growth, focusing more on consumption. Iron ore imports will unlikely grow as fast as they did before financial crisis took place in 2008 (see “Dry bulk shipping demand growth will unlikely hit pre-2008 levels“).
With more than 70% of China’s electricity generated from coal, shipping rates for capesize dry bulk vessels, which are the largest ships that transport iron ore and coal, fell on the day. The Baltic Capesize Index, an index that reflects the daily rate of transporting raw materials in the spot market for capesize ships, fell from 1265 to 1257, negatively affecting companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE) and Safe Bulkers Inc. (SB). The Guggenheim Shipping ETF (SEA), which invests in shipping companies worldwide, was also affected by the news release.
Bulls and bears for China’s economic growth
Bulls will argue the world’s manufacturing activity accelerated in March (see “Global manufacturing expanded faster, positive for shipping“), with imports rising to a record level in China (see “China’s import value hits record supporting shipping, media widely unnoticed“), and that now will be a great time to get into the market. But bears will point to the worrisome lower electricity output growth of just 2.1% in March, potentially signaling worsening fundamentals ahead.
Investors should watch out if China’s economic fundamentals deteriorates further, and protect positions that are most sensitive to the country’s economic slowdown. However, they should also take into account that markets worldwide, with the exception of United States, have been correcting since February, potentially presenting a short or long-term buying opportunity. Inflation continues to remain stable, allowing policymakers to keep a loose monetary stance.
© 2013 Market Realist, Inc.