Australian shares display material seasonal weakness in May-June, propagating the old investing adage “Sell in May and go away”.
There are several plausible contributors: 1) seasonal commodity weakness; 2) selling to offset taxable income ahead of end of financial year; 3) selling to clean up portfolios ahead of end of financial year (in Australia) or summer holidays (offshore); and potentially 5) uncertainty around the Federal budget.
Commodity market seasonality explained
Strong observed seasonality in Chinese steel pricing can have flow-on effects to other commodities, markets and currencies.
The Chinese steel cycle
The annual re-stocking and de-stocking cycles within China’s steel industry are powerful price drivers given the immense size of this +820 million tonnes per annum industry (which is about 50 per cent of world production). These cycles influence not only Chinese domestic steel prices but also interact with the price of other inputs including seaborne iron ore and metallurgical coal.
Price moves can also be accentuated by seasonal input supply disruption, political announcements and speculation:
- Peak steel re-stocking: Occurs during the Chinese winter (October-February) as mills run hardest to build steel inventories ahead of the construction season (price positive).
- Policy announcements: China’s two most influential annual political meetings – The National Committee of the Chinese People's Political Consultative Conference (CPPCC) and the National People's Congress (NPC) – occur in early March. Essentially China’s leadership showcases its policy intent for the year ahead, which in the last decade has often been stimulatory to investment and construction (sentiment positive).
- Iron ore supply disruption: Iron ore supply from the southern hemisphere suffers from peak disruption during the summer cyclone/wet season (ex-Australia and Brazil), which coincides with peak re-stocking, which can amplify iron ore prices during the Australian summer (iron price positive).
- Peak steel de-stocking: Occurs through the summer construction season (April-October) and is also affected by mills entering summer maintenance and holiday periods (Western hemisphere) (price negative).
- Market speculation: The sheer size of China’s industry and the structure of its financial markets make commodities prone to intermediation by traders and price sensitive to speculation. Traders/speculators are particularly opportunistic around the pricing cycle and around government policy announcements which can accentuate price tightness. Conversely, if prices are too high (mills unprofitable) or momentum is lacking (cyclical) then traders, speculators and often customers alike will exit physical markets or even default on cargoes preferring to source inputs domestically or draw on inventories, which can hasten price falls. This partly explains how these price cycles can be so volatile.
Resources correction arrived early this year
ASX resources stocks surged 17pc post Trump’s election, but peaked in February and have now given up almost all of those gains. Commodities and mining stocks are responding to falling Chinese steel prices and their own seasonal drivers, albeit earlier than expected this year. This is most likely a function of speculation running too hard on Trump’s reflationary promises to begin with. We now see value in our preferred resources names and advocate layered buying through the seasonal lull. Morgans current valuation for BHP Billiton is $28.18. Key downside risks to our valuation include the potential for commodity price volatility within petroleum, iron ore, copper, and coal markets.
- Boh Burima, Financial Adviser | Authorised Representative: 000341081. Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410.
