Demand for Iron Ore Cooling Off in China

By CHUIN-WEI YAP and ALEX MACDONALD BEIJING -- China's steel and spot iron-ore prices have been riding high for several months, but are likely to ebb as signs emerge that demand can't sustain the country's steel production or iron-ore imports. Boosted by the government's four trillion yuan ($585 billion) stimulus package, China, the world's largest steel consumer, recorded its highest iron-ore imports and steel production in July. However, economic data for the month showed signs of a slowdown in infrastructure spending and real-estate development, two areas that between them account for more than 50% of China's annual steel consumption. That could indicate that the demand for iron ore and steel in the second half may plateau or even decline. Iron ore is a key ingredient in steelmaking. On Monday, Fortescue Metals Group Ltd. said it had struck prices for iron ore to be sold to China below a benchmark set by Rio Tinto Ltd. with Japanese, Korean and Taiwanese steelmakers. The pricing issues have also come as China faces worker unrest as it tries to force consolidation of its steel industry. Iron-ore spot prices began to ease last week after nearly doubling since touching lows in April. Domestic steel prices also faltered following a three-month run-up. "All eyes will be on the August numbers to see if July was just post-June exhaustion or if it really did mark a change," Standard Chartered said. In July, China's real-estate fixed-asset investment rose 12.7% on the year, compared with 14.6% growth in June and 30% in 2006-07, the bank said. New project starts, which include infrastructure, dropped in July for the first time since October, according to China's National Bureau of Statistics, an indication that the "stimulus package was heavily front-loaded, meaning that investment growth may well plateau around these levels for a while," Standard Chartered said. Chinese steel and iron-ore prices began to wane because of nervousness that China may tighten its monetary policy and market sentiment that the metals may be overvalued. Industry watchers point to the correction as a red flag for overproduction. They fear that rising steel output already has eaten into the nascent demand that fueled the rally. That would be bad news for miners, which sell a large portion of their iron ore on a spot basis. "The velocity of the recovery in China has been indeed positively surprising," said Marius Kloppers, chief executive of BHP Billiton Ltd., one of the world's largest iron-ore producers. "The key question for us now is just how much of the recovery in China has been the result of pent-up demand from a much depleted inventory and how much represents underlying real demand," Mr. Kloppers said. There is also potential fallout for China's overseas investment plans. By making the quid pro quo of Fortescue's price discount so clearly linked to increased Chinese investment, shareholders in other resource deals may balk at increased Chinese investment. The opponents of Aluminum Corp. of China's failed bid for a bigger stake in Rio Tinto said China would use its power to leverage cheaper iron prices -- which is exactly what happened in this case. One of Fortescue's largest shareholders is the Chinese steelmaker Hunan Valin Iron & Steel Group, whose chairman is also a top official in the China Iron and Steel Association. Write to Alex MacDonald at alex.macdonald@dowjones.com