Iron ore hopium persists

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ScreenHunter_2909 Jun. 13 13.15

By Leith van Onselen

Andrew Roberts, the chief executive of Junior iron ore minor, Arrium, has rejected the sharp slump in the iron ore price, predicting a rebound as the market works to digest the deluge of new supply, Chinese stockpiles move to steel mills, and the Chinese economy continues to urbanise. From The Australian:

“We expect in the next one or two quarters that iron ore prices will improve”…

Mr Roberts was upbeat about long-term iron ore demand, based on China’s plans to relocate another 300 million of its people from rural to urban areas.

“I recently caught the train from Beijing to Shanghai and over that five-hour period I lost count of the amount of cranes in use in construction at 3000,” he said.

…”there is a strong belief, which we share, that the Chinese economy will continue to grow over the long term.”

While a rebound will occur at some point – markets never move in a straight line – the longer-term trend in the iron ore price is likely to be one way: down.

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In my opinion, Roberts’ arguments that China’s continued urbanisation will support the iron ore price ignores some fundamental facts.

First, that there is already an estimated 50 million vacant homes in China, hence supply is already running way ahead of demand.

Second, it is the rate of change of construction in China that is central to the iron ore price. That is, with iron ore supplies increasing sharply, construction will also need to increase at a similar rate for the price to remain stable.

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It doesn’t matter that there are some 3,000 cranes between Beijing to Shanghai if the level of construction is not materially higher than last year. The iron ore price would still fall. The same goes for the 300 million still to urbanise argument. Again, if construction does not increase materially year after year, then with growing iron ore supplies, prices will drop.

These are the key challenges facing Australia as China’s economy both slows and rebalances away from construction and towards consumption. The Chinese economy will find it increasingly difficult to maintain current construction levels each and every year, let alone increase them. And this is likely to continue weighting on commodity prices, especially iron ore.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.