This Industry Is Unhurt By China's Currency Woes

In a report published Friday, Goldman Sachs analyst Christian Lelong argued that while coal is "particularly exposed" to the recent devaluation of China's currency, the impact on iron ore market is likely to be "muted." According to Lelong, coal is particularly exposed among bulk commodities because the rest of the world relies on Chinese imports to balance the seaborne market, and imported coal must be priced competitive versus domestic coal – implying China is the "global price setter." In fact, Lelong suggested that the unexpected tailwind should be "welcomed" by the domestic iron ore industry, but a modest depreciation can only provide "limited support" to Chinese miners who are burdened with a challenging geology. Meanwhile, the potential increase in Chinese steel exports (due to a now more competitive currency) could displace some production in other countries, resulting in a "modest" net impact on seaborne iron ore demand. Lelong also noted that the introduction of tariffs and quotas should moderate the amount of "cheap" steel that the rest of the world is willing to purchase. Looking forward, the analyst suggested that the summer of 2015 will be "the calm before the storm" as peak steel production will be followed by a contraction. Meanwhile, weaker commodity linked currencies are "partly responsible" for a 35 percent decline in the analyst's estimate of margin production costs through 2016 as the depreciation in the Chinese currency "pales in comparison" to losses seen by the Australian and Brazil currencies. "In our view, the greater the delay before demand is allowed to fall towards a more sustainable level and the longer that marginal iron ore producers benefit from capital inflows and from prices hovering above marginal costs, the more abrupt the transition is likely to be," the analyst concluded.