Iron ore has replaced oil as the worst performing major commodity price in recent weeks as it is caught in a perfect storm of increasing global supply and stalling Chinese demand.
Iron ore prices are likely to keep falling given that industrial restructuring has barely begun in China and that global iron ore supply is likely to keep increasing for some time.
Steel prices in China have fallen sharply over the last year but nothing like as much as iron ore prices. Steel prices would need to fall 50% to catch down to current iron ore prices.
With China’s multi-year real estate correction in its infancy, pollution a hot button issue and steel inventories at record levels, downward pressure on China’s steel output is structural.
China’s authorities appear keen to retard these wrenching and highly deflationary adjustments with output levels of both steel and iron ore being broadly maintained for now.
Hebei province, which produces c. 25% of China’s steel, for example, has official targets to cut steel output by 40% between 2014 and 2017. It only managed a c.5% reduction in 2014.
Exporting excess domestic supply onto global markets is providing an escape valve for now. China’s steel exports have jumped by over 60% over the last year.
There is little to interrupt these dynamics in the near term. Iron ore and particularly steel prices should keep falling. China’s steel exports will further flood global markets.
Australia is inevitably the biggest loser. Even assuming flat prices from here, its exports earnings could slide by a further $20bn for calendar 2015. Fiscal implications are dire.
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.
