China Inc.: global steel dumpling time

Numbers: Equity Indices

Equity markets began the week weakly ahead of the FOMC’s April meeting minutes but concluded the week strong and above last week’s close.

  • ASX 200 closed the week 0.42% higher, sitting 58% above its 52 week low;
  • CSI 300 closed the week 0.11% higher, sitting 9% above its 52 week low;
  • Hang Seng index closed the week 0.67% higher, sitting 15% above its 52 week low;
  • Nikkei 225 closed the week 1.97% higher, sitting 30% above its 52 week low;
  • FTSE 100 closed the week 0.29% higher, sitting 41% above its 52 week low;
  • S&P 500 closed the week 0.28% higher, sitting 75% above its 52 week low; and
  • S&P/TSX closed the week 1.24% higher, sitting 62% above its 52 week low.

Equity markets week of May 16.PNG

Numbers: FICC

  • Risk-free rates used in equity valuations continue to stay low (as shown below) – adjusted WACC (weighted average cost of capital) will continue to be a useless valuation tool to DCF and LBO calculations so long as risk-free rates stand at such heavy discounts to inflation.
  • Against their 52 week lows: US Treasuries closed 24% above, Canadian Treasuries closed 40% above, British 10-years closed 18% above, and Germany’s 10-year closed 10% above.

Bonds.PNG

  • WTI closed the week 3.91% higher, sitting at the mid-point of $48.02 per barrel between the 52 week range of $31.77-$63.92 per barrel;
  • Gold closed the week 1.31% lower, sitting at $1,256.74 or 15% below its 52 week high of $1,293.53 – let’s see if Paul Singer’s comments in April to Elliot shareholders will come to fruit;
  • Silver closed the week 3.25% lower, sitting at $16.55 or 31% below its 52 week range of $13.68-$17.85; and
  • Copper closed the week 0.22% higher, sitting at $207.85, just 14% above its 52 week low of $195.9.
    • Is there a material concern over the unwind of the copper carry trade? Bloomberg Intelligence discussed this in October last year.

Commodities.PNG

Federal Reserve

FOMC April meeting minutes opened discussion for a possible Funds Rate hike in June (scheduled June 15 EDT):

A couple of participants were concerned that further postponement of action to raise the federal funds rate might confuse the public about the economic considerations that influence the Committee’s policy decisions and potentially erode the Committee’s credibility.

A few participants judged it appropriate to increase the target range for the federal funds rate at this meeting, citing their assessments that downside risks associated with global economic and financial developments had diminished substantially since early this year.

Importance of the Funds Rate is not to bank lending nor mortgage rates but global equity valuations and cross-currency swaps – these need to the central concern to FOMC decision makers given the US bond market will need some reinvigorating following three rounds of “quantitative easing”.

The Economist (Federal Reserve: the right kind of reform) correctly point out that Republicans (mostly) are chasing the Federal Reserve with schemes to increase its transparency via an “audit” by the government Accountability Office. Unfortunately, the Economist, and politicians, will find any excuse to point their fingers at irrelevant issues and let slide those of importance.

You should decide for yourself why the market moves to such FOMC announcements and having done so, ask whether the Federal Reserve should be responsible to the level of an index. If you really think that the Federal Reserve’s Discount Window, or the “risk-free 6% annual dividend” the Economist refers to, as a concern that “political gridlock has given the regional Feds growing representation on the FOMC” as a major concern, your attention is equally placed on the wrong issues.

 China Inc. Anti-Dumping of Steel

Several news outlets mid-week covered that China barked at the US for imposing anti-dumping measures (collectively amounting to an imposition of 522% in US duties and anti-dumping tax) on its steel exports.

China’s GDP continues to depend on the export Steel and Iron Ore, thus why the continued devaluation of the Yuan has become so important to the nation meeting its national output goal. The graph (below) shows the RMB movement over the last 5 years – white line is offshore Yuan and yellow line is onshore Yuan.

USDCNY Curncy (USD-CNY X-RATE) 2016-05-20 20-03-47

There is a clear divergence between the ideology (service-based) and reality (production–based) of China’s economy: annual capital allocation in China ends up in fixed investments whereas that of the US is placed into the markets. This is a conflict of interest given that the Chinese government has “vowed to give markets a “decisive” role in the economy”, as reported by the Financial Times.

While the stock market reflects ongoing inputs and fixed investments do not, when China begins dumping steel into global markets this affects the capital allocation mechanism of the US – retaliation will ensue.

While Zero Hedge charted Chinese exports of aluminium, steel and oil against Bloomberg’s commodity index until the end of 2015, I have charted Steel exports against Bloomberg’s commodity index.

The first graph shows what has been referred to as the “mountain of iron ore sat right on China’s doorstep” by Bloomberg:

Iron ore price.jpg

Iron ore inventories sit at just above 100 million metric tons in China – an equally dim picture is that of China’s steel (highlighted below).

The second graph provides a full picture to that which Zero Hedge posted May 19th.

China export vs. commodity prices.jpg

What is the play here? If the oversupply and glut in demand is true for steel, the following 17 largest A- and H-share listed companies (ranked by revenue) could see the largest hit.

Excel file with all 170 A and H share-listed companies available here: China and HK Steel Comps – First tab automatically pulls from a Bloomberg Terminal and the second tab is a copy and paste of values.

Companies 1

Equity Valuation

Equity Valuation 1

Profitability

Profitability 1.PNG

Balance Sheet

Balance Sheet 1.PNG

Market Performance

Market Performance 1.PNG

Trading Performance

Trading Performance 1.PNG

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