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Chinese property woes point to more pain for our market

Chinese property woes point to more pain for our market

News about the Chinese construction sector keeps getting worse. That’s a major issue for our iron ore miners as Chinese property construction accounts for around one quarter of all seaborn iron ore demand. As our three biggest iron ore producers – BHP, Rio and Fortescue – make up a big chunk of the ASX200, I foresee darker days not just for these companies, but for the performance of the entire bourse.

In a number of previous articles, I have detailed why the Chinese property sector is probably the single most important sector outside Australia when it comes to the future of the Australian stock market performance. To recap, this is because:

  • China accounts for about 78 per cent of worldwide seaborn iron ore demand and is by far the largest driver of seaborn iron ore.
  • China imports about 82 per cent of its total iron ore demand so any changes in overall iron ore demand will translate to import volumes very quickly.
  • Chinese property construction accounts for about 42 per cent of Chinese steel demand.
  • Chinese property construction accounts for approximately 27 per cent of all seaborn iron ore demand which is the major earnings driver for BHP, Rio Tinto and Fortescue Metals Group, which together makes up about 14 per cent of the ASX/300 Index so it is easy to see that apart from interest rates, this is the single most important driver for overall Australian share market performance.

The property development sector in China is suffering due to historical overbuild and very high reliance on different types of debt funding. A couple of years ago, the Chinese government recognised that the overreliance on property development was not a desirable feature of economic growth and put in place debt funding restrictions in an attempt to cool down the sector. This has had the desired effect but has also led to some (in their view) undesirable outcomes now coming to the surface. 

One such effect is Chinese property buyers are going on “mortgage strike” and refusing to pay the mortgages on apartments they have bought but where construction has stopped as a result of the developers not being able to access debt funding to fund construction. To understand this, we need to understand that the normal practice in China is to pre-sell apartments before construction starts and to use these funds to fund construction of the apartment complex. With the developers running out of liquidity and having to stop construction, apartment buyers are (rightfully) concerned about their investments and have recently through social media started a campaign to boycott paying their mortgages as long as the development is not moving forward.

It is certainly easy to have sympathy for this, especially as families in China often pool their money together to buy an apartment and invest all their life savings in this purchase which has led to about 70 per cent of private wealth in China being invested in property which is by far the highest number in the world. To see construction halted after taking out a large mortgage at the same time see prices falling, meaning that the apartment will most likely be worth significantly less than you paid for it if/once you get the keys, is surely disheartening.

What this does is significantly increase the risk of contagion or the risk that more and more people are adopting the same behaviour and the whole system is put at risk. We are now starting to see clear signs that this is the case with reports that some 301 projects are subject to this mortgage strike and also reports that suppliers to Chinese real estate developers are also starting to refuse paying their bank loans citing non-payments from the property developers.

This comes at a very unfortunate time for President Xi Jinping as the 5-year annual congress meeting where he is planning to get a third five year mandate as leader is due to start in November and social unrest due to people not being able to take delivery of their already paid for apartments and falling property prices are not conducive to this. As a result, the central government has directed local governments and banks to take action to help fund developers so that they can complete already paid for projects but it is not yet clear if the Chinese government is prepared to extend this stimulus to get new projects up and running and rekindle growth in the Chinese property construction sector.

Overall, the news continues to get worse out of the Chinese construction sector and this is the major reason why we continue to not own any of the Australian iron ore producers as we see further downside to the iron ore price.

You can read my previous articles here:

More Chinese property woes spell bad news for iron ore miners

Why weakness in Chinese property doesn’t support increasing iron ore prices

Why Chinese property worries affect us all

INVEST WITH MONTGOMERY

Andreas is the joint Portfolio Manager of The Montgomery Fund. Andreas joined from Navigo Partners, a M&A advisory firm in Stockholm, Sweden where he was a Director responsible for origination and execution of Scandinavian projects. Before this, he worked for three years in corporate strategy at Alinta Energy in Sydney.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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