A bullish take on China’s huge ore pile

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Mac Bank today weighs into the great Chinese iron ore port stocks debate today with a bullish explanation:

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The apparent destock reported by Mysteel certainly explains the recent price weakness but it contrasts with widely publicised data showing a strong rise in the volume of iron ore inventory being held at ports in China. In our view, the mill inventory data is the better indicator as it includes inventory that mills own in their stockyards, at port and at sea. The divergence between the two data sets seems to relate to inventory positioning, with mills now holding a larger proportion of stock at port or in their stock yard than a month ago, while the share held at sea has fallen from 49% to 38%. We also note that some sources of port stock data have added to their samples over 2014, making the rise in port inventory appear more dramatic than has in fact been the case.

Another point to note about the port stocks is that they should really be looked at relative to imports (if they are to be looked at all – in our view they are not a useful indicator). All iron ore imports will have to spend to some time at port as they are unloaded and clear customs, rising import volumes should naturally lead to an increase in port inventory. To judge whether a rising proportion imported material is ending up sitting at ports rather than being consumed, the inventory data should be divided through by the import data (on a 3mma, given the volatility of the reported import data). On this basis, port stocks remain at historically low levels, as shown in figure 4 below.

A few points to add in rebuttal. As I’ve said many times, it is unwise to directly correlate port stocks with specific iron ore inventories or underlying demand (Mac agrees) . The markets are just too opaque for that to be useful and the evidence over time is that port stocks wax and wane only in loose simpatico with prices. They should be taken as a loose proxy for the state of the Chinese iron ore and steel supply chain incorporating mills, traders, hoarders, financiers and even suppliers. Right now that rough measure is brimming.

Second, the Mac bank chart about port stocks versus imports is therefore potentially misleading. The level of port stocks tells us nothing about underlying demand. In fact, one could draw the opposite conclusion to Mac that the falling ratio of stocks to total imports is a reflection of the end-user market’s comfort with greater supply surplus not a reflection of higher end-user demand.

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Anyway, Mac concludes there is another danger to prices:

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We have been of the view that poor sentiment and tight financing conditions at the steel traders would mean that this year’s stock build would be less aggressive than what we saw in 2013. For this to be the case, we will need to see the inventory build over the next two weeks slowing compared to previous weeks but this is not too much to ask given inventory usually peaks around three weeks after CNY. Perhaps the greater risk comes from steel inventory being held by mills – this has apparently surged in recent weeks.

Exactly right. As I keep saying, steel inventories are also much higher than usual for this time of year before we’ve even had the post-Lunar New Year ramp up. Like my other post this morning, Mac Bank’s also argues that falling mill inventories are bullish and it concludes:

For now we are comfortable with our call for 62% Fe iron ore prices to average $130/t CFR China over 1H14. That recent price weakness can be linked to destocking suggests that purchasing activity should improve once that destocking comes to an end. As long as demand makes enough of a sequential improvement to allow steel production to rise back to the 800-820mtpa range (which would only be 2-3% YoY increase compared to 2013), demand for iron ore should match the supply increase expected over 2Q, keeping prices in the same range we saw for most of 2H13.

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In this event I see more like $110-120 as the average price and I don’t think it will happen without further stimulus, which I do not expect for some months yet.

In the end there are three simple facts to stick with:

  • China’s iron ore inventories are brimming;
  • China’s steel inventories are brimming and steel prices are very weak compared with past years during this period, and
  • China’s macro indicators are slowing while authorities continue to warn of, and execute, steady tightening.
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About the author
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.