(The author is a Reuters columnist. The opinions expressed are
--Clyde Russell is a Reuters market analyst. The views
expressed are his own.--
By Clyde Russell
LAUNCESTON, Australia, Nov 5 Iron ore and steel
prices were buoyed by the strength of China's manufacturing
indexes, but there is a risk the market is focusing on the wrong
The official Purchasing Managers Index (PMI) hit an 18-month
high of 51.4 in October, while the HSBC measure reached a
seven-month peak of 50.9.
Both PMIs indicate improving conditions in China's vast
manufacturing sector and this was enough to spur gains in iron
ore and steel prices.
But at the same time that the manufacturing indexes were
looking up, the PMI for China's steel industry was heading the
The steel PMI dropped for a second month, falling to 47.5 in
October from 49.2 in September, according to the China
Federation of Logistics and Purchasing, which compiles the
The decline to well below the 50-level that separates
expansion from contraction on a monthly basis was driven by
falls in overall production, finished product inventories and
new orders, according to a Morgan Stanley research report
e-mailed on Nov. 5.
The decline in the steel PMI fits with some other evidence
that not everything is rosy in the sector, with average steel
output falling 1 percent to 2.107 million tonnes in the second
10 days of October.
The drop was the second consecutive decline, following a 1.1
percent fall in output in the first 10 days of October,
according to data from the China Iron & Steel Association.
The volume produced was also the lowest since the 10 days
ended July 31.
There are also indications that steel inventories are
rising, with association figures showing stocks at 13.2 million
tonnes, up 3.1 percent since the end of August.
It's likely that this inventory build-up has continued in
recent weeks, meaning that the mismatch between steel output and
consumption may be increasing.
It also doesn't appear that exports are taking up some of
the slack, with steel product exports dropping 4.4 percent in
September to 4.92 million tonnes from a year earlier, according
to customs data.
Year-to-date exports are still up 14.6 percent, but this
strength seems to have built on exceptionally robust shipments
in July and August, which recorded gains of 19.1 percent and
44.9 percent respectively.
So, what should the market believe? The emerging strength in
the manufacturing PMIs or the weakness in the steel PMI?
As is often the case, the contrasting PMIs aren't
necessarily at odds with each other.
It's certainly possible to have improving conditions in
manufacturing and weakening fundamentals in steel at the same
In theory, an improving industrial sector PMI should act as
a spur to the steel industry by boosting demand for metal
products, but it still may be the case that in China spare steel
capacity is larger than any potential increase in consumption.
What the steel PMI shows is that there is still likely
over-production happening in the sector, which means the recent
rebound in benchmark Shanghai Futures Exchange rebar
may not be sustained.
The contract is up 2.5 percent since hitting a four-month
low of 3,585 yuan ($588) a tonne on Oct. 28, closing at 3,673
yuan on Nov. 4.
Iron ore prices have outperformed steel, with spot Asian
iron ore .IO62-CNI=SI up 3.5 percent since Oct. 28 and the new
Dalian Commodity Exchange's most active contract
gaining 3.7 percent over the same period.
If there is a contrast in the steel sector, it's between the
ongoing robust demand for iron ore and the weak profitability of
China's iron ore imports are up 9 percent in the nine months
to September over the same period in 2012, with the third
quarter recording the first-, second- and fourth-highest monthly
October imports are likely to be strong as well, given the
3.2 percent on-month rise in September shipments from
Australia's Port Hedland, the main export port for iron ore.
However, at some point the overcapacity in China's steel
sector will have to be addressed.
While the recent gains in the manufacturing PMIs provide the
possibility of rising demand in coming months, the problem of
structural overcapacity remains.
(Editing by Joseph Radford)