Why is construction so important for tracking iron ore demand?
About 98% of mined iron ore finds its way into steel production, and construction accounts for 50% of the steel consumed. So for investors to understand the direction for iron ore demand, it’s very important to track the direction of construction activity—and particularly Chinese construction activity.
There are still many factors you can track to understand if construction activity is expanding or cooling down. Let’s take a closer look.
Real estate index
China’s real estate index is a composite index based on eight sub-indicators like land, capital, and sales, which reflects the current situation and development trends of real estate market. Its data is released monthly by the National Bureau of Statistics (or NBS). Iron ore investors should watch this indicator, as it gives a good estimation of China’s housing market and thus demand for iron ore.
As you can see from the graph above, the real estate climate index is going down. This shows pressure in the real estate market.
Housing prices are an important gauge for understanding the direction of residential activity in an economy. Housing prices fell for the third consecutive month in July. Worse news is that the decline seems to be picking up pace. In May, prices fell 0.32% month-over-month (or MoM). In June, they were down 0.50% MoM. July’s data came down 0.80% MoM. This data is provided by the China Real Estate Index System Survey monthly, according to a survey of 100 Chinese cities.
This decline is partially a result of Chinese government campaign that started in 2009 and aimed to curb rising housing prices. Measures included increasing the down payment, increasing mortgage rates, and imposing homebuying restrictions.
However, given the unintended consequences recently, property rules have relaxed in many cities in China. The central bank has also started encouraging banks to extend mortgages. Developers have started attracting buyers by giving discounts and offering other incentives.
Home sales and inventories
Overall home sales have decreased 9.2% YoY in the first half of the year compared to a full-year increase of 26.6% in 2013, according to the National Bureau of Statistics (or NBS).
Unsold new homes in the 20 large cities increased to an average of 23 months of sales in June
Mortgage lending rose 6% in June to 117 billion yuan from the previous month, compared to 2.5% MoM growth in May. This is because the government has relaxed the rules for mortgage lending.
All the above data points show that construction activity in China has started to cool.
Analysts are suggesting that property market weakness remains the single biggest risk facing the Chinese economy. This will have a fall-out impact on the construction and steel industries.
This in turn will have a negative impact on iron ore prices and therefore on iron ore stocks like Rio Tinto (RIO), BHP Billiton (BHP), Vale SA (VALE), and Cliffs Natural Resources (CLF). It will also negatively affect ETFs investing in iron ore stocks like the SPDR S&P Metals & Mining ETF (XME).