Weekly Wrap by Pythagoras Investing: Will China Boycott Iron Ore?

Coronavirus waves are moving back through Europe with France and Germany re-initiating lock-down measures.  The US dose of the pandemic is accelerating rapidly. These factors along with the US election are causing markets to fall.  The question of who wins in the US Election is anyone’s guess – but I know who I don’t want to win!

That aside, the Chinese are threatening more and more of our exports.  And the amounts are material.  China has targeted Australian barley, beef, wine, coal and cotton since Australia led calls for international inquiry into origins of the coronavirus in April.  Two-way trade between China and Australia is worth around A$240 billion, while China buys around 39 % of Australia’s merchandise exports.

Australia also did not consult China about plans for the inquiry before pursuing it internationally, which offended the Chinese government, according to a speech made in August by Wang Xining, the deputy head of mission of China‘s embassy in Australia.  Read more here.

What do the trade prohibitions mean for Australia?

  • China is Australia’s largest barley export market, buying around 70% of Australian barley.  Australia sold an average of around A$1.2 billion of barley to China a year.
  • China is Australia’s number one market for beef by volume, accounting for around 25% of Australia’s total beef exports.  In 2019, Australia exported about 300,000 tonnes of beef to China, worth A$2.7 billion.  The four banned abattoirs are major producers of beef and are said to account for around 33 of beef exports.
  • China imports nearly 40 per cent of Australia’s wine production worth A$1 billion a year. The Chinese wine industry is pitching for a duty of 200% to cover losses, a tax that could effectively “close the market”. Australia’s exports of thermal coal for power stations and coking coal for steelmaking to China reached A$14 billion in 2018-19. Coal is Australia’s third largest export to China, after iron ore and natural gas.  So far, as the “block” on coal is not formal, the Australian government is still trying to confirm its existence.
  • Around 68% of Australia’s cotton is sold to China, with exports last year reaching a value of around A$750 million.

The Chinese Communist Party leadership has just wrapped up the fifth plenum (its most important political meeting) where the discussions focused on how China can steady its course of development at a time when the world is at a crossroads.  Self-reliance is a theme of the five-year plan, as China braces for the threats of decoupling and diminishing globalisation by pivoting to its domestic economy. The strategy, called dual circulation, would see China remain open to foreign investment and trade, while pivoting to build an internal economic ecosystem less prone to external sanctions and turbulence.

Will China target Australian iron ore?

Being self reliant in iron ore is difficult for China which buys 60% of it’s iron ore from Australia. The value of that export is likely to hit A$80 billion in 2020.  The risk to Australia is that China buys 80% of our iron ore.

There is no guarantee that China won’t boycott iron ore, but observers believe that Beijing is unlikely to target Australian iron ore exports due to their heavy reliance on Australian imports of the commodity.  Creating new sources of iron ore is capital-intensive and will take a long time (eg Africa). China could also look for more iron ore from its second largest supplier, Brazil’s Vale. There is little doubt Vale will increase exports to China, but they face significant production difficulties.

We believe that Australia will continue to supply most of the iron ore that China needs even if trade tensions continue.

On cup day brace yourself for who wins the race that stops the nation, who wins the US election and if the RBA moves rates.  Only one is likely to move markets!

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