Economic reforms in China aimed at shaving off excess capacity has resulted in a stronger demand for Australian commodities such as iron ore, says T. Rowe Price.
According to T. Rowe Price’s 2018 outlook for Australian equities, Australia’s mining sector looks set to “make a positive contribution to growth” thanks in part to higher demand from China.
“It is interesting to note that recent Chinese reform aimed at shutting down excess production capacity has actually been broadly positive for commodity stocks, particularly in Australia,” wrote T. Rowe Price head of Australian equities Randal Jenneke.
A strength of the Australian mining sector is that its commodity production of iron ore and coal is of “very high quality”, Mr Jenneke pointed out.
“Despite capacity in China being shut down, specifically in lower-quality, inefficient blast furnaces, we are actually seeing an increase in demand for higher-quality, ‘cleaner’ commodities,” he wrote.
“This reduction in Chinese capacity on pollution grounds is one of the main reasons behind the sharp rise in Australian iron prices.
“In the quest to be more efficient and more profitable, the remaining Chinese companies are buying higher-quality iron ore and coal products.
“This is a positive for Australia given it has more high-quality iron ore than anywhere else in the world.”
He added that the mining sector looks likely to contribute positively to Australian growth in 2018, following three years of being a drag on growth.
“Stronger commodity prices are certainly driving this improvement, but they also reflect the recovery in capital expenditure we are seeing,” Mr Jenneke wrote.
“When demand for raw materials started to fall in 2014-2015, the mining companies cut their capex dramatically and, ultimately, went too far. These same companies are now starting to ramp up capex once more in response to improving demand.”
In addition, new and skilled, higher-paid jobs are being added to the sector, which is a positive development for wage growth in Australia, which is “currently at multi-year lows”.
“The lack of wage growth has been a concerning failure of the economy in recent years, so any improvement here is most welcome,” Mr Jenneke said.
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