Last week I gave extensive coverage to a range of terms of trade shock stress tests conducted by the IMF on Australia. Sadly I must now discuss the same phenomenon as a realistic prospect.
Over the last few days, there’s a bit coverage about how various iron ore barons and miners are “confident” of future prices. The Oz is typical:
FORTESCUE Metals Group expects iron ore demand to remain strong, adding to the sector’s confidence in the China growth story.
The West Australian miner, releasing its quarterly results yesterday, added its name to the list of major producers ignoring market nerves to confirm that Asia’s appetite for the steelmaking commodity was still firm.
Chief executive Nev Power said the miner had continued to sell all of its production in the September quarter despite a small drop in price.
Global major Rio Tinto’s chief executive Tom Albanese said last week the fundamentals for bulk-traded commodities were holding up well, as he released the miner’s quarterly results, which showed its iron ore output hit a new record.
Brazil’s Vale, the world’s biggest iron ore exporter, is also upbeat on the outlook and last month forecast demand would remain strong because of growth in the Chinese economy and infrastructure investment.
The expected strong demand comes despite a small drop in the price of iron ore, which Fortescue said was a carry-over from financial uncertainty in Europe.
Advertisement
While the miners might be upbeat and want to blame Europe, the ore price is actually falling because China is aiming to slow, to some unknown extent, it’s fixed asset bubble. And, the signs are that it is succeeding.
Reuters has good take on the internals of the ore market:
Spot iron ore prices may extend losses this week after sliding to their weakest in more than 11 months as benchmark steel futures in top consumer China fell to a 14-month low on Monday.
Shanghai steel futures slid more than 3 percent in their steepest decline since June 2010 on mounting worries about too much supply in China and sluggish demand.
Supply of iron ore in the spot market has risen sharply with cargoes meant for long-term, or three-month, contracts being sold at spot rates because Chinese mills were not keen on buying the material at contract rates that are far higher than spot.
Here is a chart of iron ore futures from yesterday:
Last week’s brief recovery has given way to a new plunge and swaps are now down over 20% in this correction, our traditional measure of a bear market (for what that’s worth).
The longer term chart is not encouraging either:
I have observed previously that neither the double top nor break of the 200 day moving average bodes well. The correction has also passed the base support pattern created from the breakout in September 2010, and given the price is now well below the long term moving average (200 SMA), the target is the congestion area from July-Sept 2010, somewhere in the region of $100-$120.
Meanwhile, the spot price fall has begun to accelerate in pursuit of the swaps price. Yesterday it fell $4 or 2.6% to $153.40. The swaps market is more volatile than spot but not that much. Prices have further to fall.
Westpac released a note yesterday, warning of just this:
Spot iron ore prices price have fallen quite sharply over the last 2 weeks, down 8% to $158/t. In the last 4 weeks, Australian spot fines, as measured by the TSI, are down almost 12% landed in China.
While the Dec qtr iron ore contracts will be broadly in line with the Sep qtr contracts, if the spot prices maintain the current level for the remainder of the Dec qtr, the contracts would fall around 13%. But that is not the end of the story. Brazilian prices have fallen by a larger 16% and historically, where Brazilian prices go Australian prices tend to follow:
There are also further signs of an easing in Chinese demand for steel. Rebar prices are down almost 5%mth while hot rolled coil is down 6.3%mth. Furthermore, Chinese steel scrap prices are down 5%mth & Chinese domestic iron ore price have fallen almost 6%mth.
Given the greater than normal rise in inventories over the last 6 months (+12%) Westpac has been looking for a correction to iron ore prices. As the correction unfolds we reaffirm our forecast for a low in spot iron ore prices around US$140/t in mid 2012.
Remember the price has already fallen further and since the September peak, prices are down some 15%. To my mind, the Westpac forecast of a mid 2012 low looks bold. On a technical basis, price support looks somewhere closer to $130 and looks likely to come much sooner as well.
With Chinese inflation having peaked and perhaps offering scope for monetary easing late in the year, there is reason to believe that prices can stabilise at such levels. If so, that would represent a 22% fall in the price of ore exports in January next year. On the Westpac forecast, it’s still 16%.
I have less detailed information on the metallurgic coal price but, again, the price has been falling significantly. Also from The Oz two weeks ago:
THE price of coking coal could fall to $US200 a tonne by the end of the year as production continues to rebound in flood-affected Queensland.
…Coking coal has been above $US300 for most of this year.
In historical terms, the price remains extremely high. It traded around $US50 a tonne before the resources boom.
Analysts said demand remained strong for coking coal, used in steelmaking, and supply remained the biggest influence on price.
…UBS commodities analyst Glyn Lawcock said yesterday the coal price would continue to fall as supply recovered, but the risk of further wet weather in Queensland was a “wildcard”.
“Our view is that it will continue to fall” for the remainder of the year after being high due to the floods in Queensland, he said.
“Prices should continue to ease, barring unforeseen weather events in Queensland — that’s the wildcard.
“We should see prices come down to the $US200 level either late this year or early next year.”
Here’s the latest metallurgic coal price chart (which is delayed a week or so):
I’ll aim to get a more up to date price later today. It is clear, nonetheless, that metallurgic or coking coal is also down 10% plus and falling. Thermal coal is stable.
Thinking optimistically, if it were to stabilise in the $250 per tonne region, that would still represent a 20% or so fall.
Unfortunately, the ABS does not (unbelievably) split coking and thermal coal export data for the general public so we don’t know what percentage coking coal represents of total coal exports.
But, as a simple excersize to give you some idea of where we’re headed, let’s refer to Rumplestatskin this morning, who shows that iron ore alone represents almost 30% of the export basket that makes up the terms of trade. Coal makes up another large component above 20%:
The strong relationship between the value of the Aussie dollar and global commodity prices also results in volatility in the terms of trade. A decline in the dollar will increase the price of imports, while a contemporaneous adjustment in the price of commodities will reduce the price of exports. As a demonstration, a 15% decline in the AUD (in trade weighted terms, which is where the dollar was at in Sept 2009), coupled with a 30% decline in iron ore and coal only, would result in a 30% decline in the terms of trade.
There’s some guess work in these calculations in terms of import prices. But a rule of thumb guide is that, because the weightings of coal and iron ore are so high, there’s an almost a one to one relationship between the combined bulk commodity prices and the terms of trade, so long as the dollar’s fall remains at around 50% of the bulk pricing falls.
So, if we use the conservative Westpac projection of a 16% fall in the value of iron ore and a 5% fall in value of total coal exports (which is obviously a very conservative guess because we don’t know the coking coal weighting), that would translate to a terms of trade fall around 12% in January next year.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
