LAUNCESTON: Commodity markets like to throw up little ironies, the latest being China's steel futures having their worst week on record just as economic data came out that provided fundamental support for prices.
The most-traded steel rebar contract on the Shanghai Futures Exchange lost 12 percent last week, the biggest weekly drop since the instrument was launched in 2009.
It is now down some 25 percent since its closing peak this year on April 21, unwinding some of the 80 percent rally it enjoyed from the record low in December last year.
The retreat in steel prices last week came just ahead of data on May 14 showing that property investment is one of the few bright spots in the Chinese economy.
Real estate investment rose 9.7 percent in April from a year ago, according to Reuters calculations based on data from the National Bureau of Statistics, the same as in March.
The bureau also said that new construction starts in the first four months were up 21.4 percent from a year ago, measured by floor space, accelerating from 19.2 percent in the first three months, while the area of property sold grew at the fastest rate since April 2013.
Given that construction is a major consumer of steel, the figures provided some justification for the rally in rebar prices this year, especially when taken together with rising spending on infrastructure.
The positive picture from the building sector was the standout from the weekend's release of economic data, which mainly showed that the Chinese economy is still struggling for momentum.
Growth in factory output cooled to 6 percent in April, disappointing analysts who expected it to rise 6.5 percent on an annual basis after an increase of 6.8 percent the prior month.
Fixed-asset investment eased to 10.5 percent in the January-to-April period, down from 10.7 percent in the first quarter, while retail sales rose 10.1 percent in April, slower than the market forecast for 10.5 percent.
These are far from disastrous economic numbers, but they do underscore that China is struggling to re-ignite its economy, even if the construction numbers were positive.
But where does that leave steel and iron ore, both of which have had massive rallies followed by sharp declines.
There is little doubt that the first four months of the year saw steel and iron ore enter bubble territory, with the gains not justified by the underlying fundamentals.
Spot iron ore jumped 86 percent from its record low in December to a high of $68.70 a tonne on April 21.
Efforts by the authorities to calm markets saw China's domestic exchanges increase margins and transaction costs, measures that appear to have worked given iron ore has dropped back 22 percent to close oat $53.50 a tonne on May 13.
The key question then becomes what are reasonable price levels for iron ore and steel in light of the relatively strong Chinese property market?
CORRECTION NEARLY OVER?
Iron ore prices have been supported by growth in imports, which rose 6.l percent in the first four months of the year from the same period in 2015.
This is largely because Chinese steel mills responded to the surge in prices by ramping out output, which hit a record high of 70.65 million tonnes in March, before easing slightly to 69.42 million last month.
It's doubtful that these elevated rates of steel production can be maintained for long before a glut of product eventuates, even taking into account rising activity in construction.
Simply put, such is the overcapacity in the Chinese steel sector that if it continues to produce at near record rates, it will overwhelm even the most optimistic views on demand growth.
This makes it likely that steel prices still have further to fall, until they reach a point where the highest-cost mills are once again forced to idle production.
This in turn will likely drag iron ore prices down as well, but maybe not too far given there are some positive signs on supply, with the majors trimming their output guidance and the slower-than-expected ramp up of the last of the mega-mines, the Roy Hill facility in Western Australia state.
There is always a risk that after an overly-exuberant rally the correction is equally overcooked, but the signs are that steel and iron ore may not have that much further to drop before they trade at levels more in line with fundamentals.
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