Gold News

Australia's Great Red Hope

Forlorn hope at that. But don't tell the government...

MAYBE this is the bottom for iron ore, the great red hope for Australia and the government, writes Greg Canavan in The Daily Reckoning Australia.

Maybe a resurgent price will deliver a windfall for the government, boosting the budget and helping them to avoid the need for tax reform.

It would be handy, wouldn't it? Because the government doesn't have a tax reform agenda. Its only credible plan is scaremongering.

First, a little hopium from today's Financial Review:

"Treasurer Scott Morrison is facing a potential multibillion-Dollar revenue windfall as he prepares his first budget, with a surprising rally in the price of iron ore coming at just the right time for the government.

"The commodity has surged to its highest level in three months – putting it back to about $US48 a tonne – as Chinese steelmakers ramp up production after their Lunar New Year break, a sign that global demand for iron ore could increase significantly in coming months."

The simple fact is that the iron ore price jump relates to China's massive surge in new credit over the month of January. China created a record amount of new debt last month. The figure was an astounding $525 billion.

Simon Rabinovitch, of the Financial Times, tweeted that if the new debt creation for the month were an economy, China's January effort would make it the 27th largest in the world!

This is not the first time the iron ore price has received a boost from China's attempts to stimulate its economy. During the iron ore bear market that began back in 2011, the iron ore price had big rallies in 2012, 2013, and a lesser one in 2015.

This is just another episode. The bottom line is that the market is in structural oversupply. The only way to improve the structure is via a falling price.

So this bounce will be short-lived, like the others. That's especially the case because China isn't managing its banking system very well. Soon after the news of January's record credit creation, rumours surfaced that China would reign in some of the banks.

One minute they're lending too little. The next they're lending too much. In a major worry for the ongoing build-up of risk in China's financial system, apparently 75% of January's credit creation went to corporate borrowers, an already heavily indebted sector.

According to Bank of America Merrill Lynch much of the credit is going to local governments:

"Today, 21st Century Business Herald cited a manager of a local government funding vehicle (LGFV) in a Western province as saying 'the situation is completely different from last Jan's – the banks are now chasing us to grant us loans.' This supports our findings late last year that the government seems to have abandoned its plan to curtail local government borrowings."

Hmmm. 'Late last year' was when the iron ore price bottomed. Traders obviously realised another credit induced demand surge was on its way. The question is; how long will the bounce continue? If the demand is just going towards more unproductive investments, which is the likely scenario, then it won't last longer than a few more months.

For what's it's worth, the iron ore futures market isn't overly excited about the recent price move. 2018 futures suggest a price of around US$32 per tonne.

So don't expect the iron ore price to bail out your budget, Mr.Morrison. The best you can hope for is a bounce into May to upgrade your long-term price forecasts and delude yourself that you have more revenue to play with than you actually will.

The fact that the main market index, the ASX 200, remains in a strong downtrend tells you the stock market doesn't see an economic resurgence coming anytime soon. That could change of course, but if you have respect for your money, take note of what the market has to say over any self-serving 'opinion'.

Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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