China’s Economic Slowdown and Mongolian Stocks

Mongolian mining stock prices have been falling during the last six months, although not much has changed in Mongolia besides the talk of increasing the government share in Oyu Tolgoi in October. The reason for this cool-down is mostly due to the change in demand expectations for Mongolian mine products, because recent drops in key commodity prices and China’s declining industrial output indicate that China may be headed towards significant slowdowns. This slowdown is engineered by the Chinese government, which has been tightening its monetary policy to fight inflation and to cool downits real estate sector.As a result, demand for construction related commodities such as steel, cement and copper have seensome decreases ¹, and manufacturing sector is also following suit .²

Demand for raw materials from Mongoliacould slow down at least in the next few months. Although Mongolian products have dramatically lower prices and consequently a cushion against this demandshock, investors’ confidence in China’s growth changes with news about its government-engineered slowdown, which is creating downward pressure on Mongolian mining stocks.

Financial Times ³  reported that iron ore prices fellby 30% to a 15 month low following weeks of production cuts in China at the end of October- a direct result of the production cuts at steel mills in China. The consultancy MySteel estimates that in recent weeks, 5% of China’s steel production has stopped due to the scarcity of credit. As China continues to raise its interest rates, steel sales are slowing because40% of steel demand in China are tied to the housing sector ⁴ . The customers of steel mills are cutting purchases because of falling sales and difficulty obtaining credit.

The slowdown in steel demand means that the demand for its key ingredients, coking coal and iron ore, will also decrease. Mongolia exports both of these, so export sales from Mongolia have risks of slowing down too. However, since the Mongolian commodities are priced lower than the seaborne Australian and Indian products, the demand for the more expensive commodities will fall first before any economic slowdown cuts into the demand for Mongolian mine products.

Aside from commodity price trends, other direct measurements also show that China’s economy is slowing down. One of the indicators of China’s economy is the Purchasing Managers’ Index (PMI) of the manufacturing sector published by the China Federation of Logistics and Purchasing. In October, the PMI for the manufacturing sector fell to 50.4 from 51.2, contrary to the median forecast of 51.8 by 16 economists that Bloomberg polls each month . The value of 50 is the dividing line between expansion and contraction in PMIs, and 50.4 is barely on the expansion side.

Bloomberg reports that other similar indices for different sectors of the Chinese economy indicate a general slowdown too. Chinese government’s PMI for the non-manufacturing industries fell to 57.7 from 59.3 between September and October. This indicates that the non-manufacturing sector grew at a slower pace this October. The same index showing new orders in the construction industries fell to 50.5, and the real estate activity index fell to 48.7.

Investors’ confidence in Mongolian mining stocks is directly related to the outlook on China’s economy. Although the current slowdown is due to the government’s efforts to cool the growth, but there could be deeper problems in China’s economy – the structure of China’s credit market is largely opaque. Thus, it is difficult to predict how abrupt and intense any shortage in credit may become.It is too early to tell if China will smoothly transition to a lower growth rate, or go into contraction first.If China goes into contraction, the prices of Mongolian mining stocks will suffer. It is important to continue observing the events in China very closely.

However, if China’s economy is able to smoothly transition to a slower growth rate, this period of uncertainty presents a good opportunity to buy cheap Mongolian stocks.

1.  Leslie Hook, “Iron ore plummets to 15-month low”. Financial Times, 2011/10/25.
2.  Paul Panckhurst, “China Manufacturing Index Falls, Bolstering Case for Wen to Loosen Policy”.Bloomberg, 2011/11/01.
3. See 1.
4.  Leslie Hook, “China steels itself over policy tightening”. Financial Times, 2011/11/02