Severe shock coming as China construction ‘cliff’ looms

When considering the future of iron ore there are two important charts for China to remember.

The first is the flow of floor area starts, which is the number of new buildings begun for construction over a given period.

Last year, that flow was far worse than anybody predicted.

Chinese developers cannot get the money to build any new projects.

So the floor area fell by more than two-thirds from the peak and the current sales project even further falls.

However, as doomed as construction volumes appear in terms of new building starts, actual building activity as measured by “building under construction” is much less terrifying.

In fact, the measure of the stock of building floor area under construction is down by only 11 per cent from the peak:

Some of this huge gap can be explained by the delay between breaking ground on a new project and completing it. Naturally, it will take time for the construction stock (its volume) to catch down to the number of starts (by floor area volume).

Goldman Sachs has labelled this gap and delay the “completions cliff”, the point at which the two charts converge.

That convergence point has very negative implications for Australian bulk commodity demand.

But there are complicating factors. Some developers have started, stalled and restarted developments, so they are registering as “under construction” but not new starts.

Others have access to public financing, so they complete projects and run off the “under construction” figure.

This makes the precise timing of the “completions cliff” challenging to judge.

What we can say is that this year began with a significant drop in completions, suggesting the cliff is near, and the completions trend has a pretty good correlation with the iron ore price.

In conclusion, there are doubts about when Chinese property construction volumes will genuinely crash.

What we can say is that the crash is unavoidable, the largest ever witnessed in the galaxy and it is coming sooner rather than later.

If you think that Canberra is prepared, then guess again. David Llewellyn-Smith is chief strategist at the MB Fund and MB Super