This is absolutely vital for analyzing a large part of the Chinese economy that relies heavily on easily processed goods, high volumes and high capital outlays in heavy machinery. How does one actually go about this process and finding useful information? Finding iron or coking coal prices isn’t the easiest of endeavours and spot doesn’t mean much anyway, because prices tend to be locked in at longer term contracts, so what to do?
Read off nickel charts instead. Trading here is more agile, and prices act as an indicator due to the parts in nearly all the related industries that require stainless steel which also tend to use normal steel. The nickel price is normally around 90% of the supply chain price for material, and in a lot of cases it is necessary to state what prices of nickel you are referring to. Because these prices are also available to clients, they tend to adjust their stainless steel orderflow based on the nickel trend (load more if it’s rising and store it if possible, or offload whatever inventories now and buy as much as possible on spot if prices are falling). Therefore, there is a rather high correlation between inventories and price of nickel, and this stems from the downstream decisions of relatively slowly processed and transported bulk quantities throughout the supply chain. Also, profit margins are extremely slim and dealing with other related commodities is not particularly profitable in China. So, given that, please take a look at the nickel prices at the London Metal Exchange.
An ugly view:
What is visible here is the trend similarities, and that it seems like the inventory trend will direct the price action slightly. For our more direct purposes of analysing where price can go in the shorter term, it would help to look at the 1 year and below timeframes, but it is relatively boring: two similarly negatively sloping lines! With that as a given, here is the final piece of information for comparison: Stock prices of Angang Steel and Maanshan Iron for the last three years. Adjusting for the trend of more negative performance with the stocks than the commodity or its inventories, it becomes a rather good indicator in terms of market sentiment. Feel free to toy around with the time frames to find the level of granularity that suits you, but in my view this is a rather big macroeconomic matter and warrants a 3yr+ frame: China has had its currency rise among the fastest of competing nations in the emerging market space, profit margins are thin, competition is growing and inflation is pushing costs of labour up tremendously in China given its stellar post-Lehman performance. All of this puts the steelmakers in a squeeze that they are particularly vulnerable to, and over the longer term the negative trend relation to the LME data needs to be adjusted for both to evaluate shorter moves and to get a grasp of wider trends.
Why the eyesore is worth the trouble:
Applying this to the related stocks, we can see pretty fast that what enabled their fall to stop was the combination of the wider equity markets catching up, and the support it got from the nickel market on the one month frame. The coming few days are likely to be extremely volatile in the equity space, but my advise would be to try and disregard the volatility that comes with it and focus more strongly on the nickel market. You can get volatility exposure everywhere, but there is a strong correlation here with something else outside the pure HSI money flow situation that you can play off of for diversification purposes, and that’s why it is a given on my watchlist.
Longer term, things look grim. Stock prices have utterly been pummelled while the inventories haven’t to the same extent, and a wider contagion to markets that would severely restrict worldwide nickel demand would be a very, very disheartening signal. Inventory trend is firmly down, it still remains to be seen if the last one month stabilization in price will feed through, but that would be a hazard play. This means that these equities will only be on my short term bullish watch list for as long as nickel prices go up, and I would consider translating that into a firmer, actual (cash) position and do the related research at the time if inventories show signs of picking up. I forecast this to be rather far away though, given that inflation is still high in China, the currency is going up, and I forecast policy easing to occur in early next year if at all. Still, this is essentially my window into Chinese industrials, and one of the kernels of information that I keep a close eye on to get a better view of nearly everything from steel rollers to appliance- and car makers.