As a business, it's our job to watch out for early market signs of changes up ahead.
One which has come up on our radar is the large moves we have seen in Chinese steel prices, down almost 20 per cent below where they were three months ago and following a recent turning over in the iron ore market.
The pertinent question is whether this is driven by a global decline in demand from slowing economic activity levels.
Broadly speaking, Chinese steel price weakness may not have come as a surprise to close observers. This is given the recent falls in China in the Caixin purchasing managers indices, which are forward indicators of manufacturing activity.
And let’s not forget the backdrop of a trade war with the US, the possibility of growth having peaked (for the time being at least) and the tough times in the auto sector. But in this case, it could be supply rather than demand which is causing trouble.
Chinese production has increased at a rate of almost 10 per cent over the past 12 months. In contrast, other steel manufacturers have held volumes flat to slightly down, with the exception of the US, which is also posting double digit increases over the period.
The increasingly insular policies of the Trump administration perhaps explain why US manufacturing has increased at the expense of others; it’s protectionism in action.
Yet the Chinese increases are more perplexing. China runs a large surplus in the trade of steel (unlike the US), meaning it exports far more steel than it imports. Why then would it ramp up production in the face of a potential slowdown?
We think clues may be found elsewhere. The Chinese government enacted supply side reforms in 2016 to try and handle excess capacity by closing some of the less efficient mills and improving the profitability of the remaining companies.
Capacity has fallen while profitability has increased enormously, even as prices of steel have fallen over the last year.
Earnings before interest and taxes margins are almost 5 per cent higher than they were the last time steel was this price. Even before the slowdown, those efficient plants were working flat out to increase production.
The last few quarters of sluggish data may have taken us through a tipping point. It seems the Chinese leadership’s announcements of further infrastructure investment plans were accompanied by an easing back of pollution restrictions on the older producers.
As fans of Chinese industrial production numbers will know (!), they tend to be 6 per cent. Occasionally there will be peaks and minor troughs, but since 2015 this number has been between 5.6 per cent and 7.6 per cent a year.
A command to produce more would seemingly help economic activity. It may explain why prices have fallen back, adjusting to an increase in production by the world’s largest steelmaker. Unfortunately, the customers may turn out to be less willing or able to buy than first thought.
Of course, whether this downturn in steel prices drives a quicker shuttering of excess capacity is another question.
With a trade war looming, central government might well look favourably on an industry that can increase production. This is especially if true they can remain profitable despite dropping prices for producers all around the world and thus overcome some of the new US tariff hurdle.
In that case, those set to suffer most would be other steel producing nations without tariffs to protect them from this Chinese excess capacity entering the market. This will be at very low cost, and may happen through either competitive advantage or 'dumping', that is, state-sponsored sales below the cost of production.
Those highest on this list are Japan, India, and Russian steel industries. Of course, the largest producer in the world getting more efficient over the medium term is likely to mean these markets face a headwind beyond this year’s increase in production.
Saudi Arabia embarked on a similar strategy with oil to undermine the US shale producers. And as we saw with the oil price then, this is not good news for anybody in the wider trade.
Sadly, this constitutes yet another headwind for emerging market economies. It's one they could really have done without, having just had to deal with the resurgent strength of the US dollar.