How big the ore bounce?

So, with a temporary floor under the ore price, it’s time to ask how big is the bounce likely to be? We have had a solid rebound so far with spot up another 1.7% last night to $125, 12 month swaps are at $129.50 unchanged and Shanghai rebar is also flat. According to Reuters, traders are getting bullish:

Iron ore prices are likely to stretch gains this week as more mills in top consumer China return to the market to replenish inventories, but a wobbly outlook for steel demand may cap the upside.

Iron ore, which fell more than 30 percent in October, began stabilising last week, gaining more than 8 percent, as Chinese demand picked up.

“There’s more buying interest from the mills, but some traders and miners are also holding off for better prices,” said an iron ore trader in Shanghai, adding that some Indian miners had canceled tenders last week at the last minute, hoping prices would move higher this week.

…”The price rise will not be so fast,” he said.

“Sentiment is cautiously optimistic. We still need to pay more attention to steel demand in China which has not shown any significant change.”

…Macquarie expects iron ore prices to rebound in coming weeks after stability returned to the market last week.

“We would reiterate our call that iron ore looks oversold at current levels,” Macquarie said in a note.

“After (last) week’s stabilisation, we believe the iron ore price could recover a further $20/tonne rapidly as the balance of power shifts back to the sellers amid low inventory conditions and a stabilised steel market.”

Well, let’s take a look. Here the latest China port inventory chart:

I’ve marked the last really big inventory cycle in late 2008. As you can see, today’s draw down hardly even registers. So, either this cycle will be small and brief, or it has hardly begun. To my mind the latter is more likely at this stage and I have three reasons.

The first is the Chinese ongoing commitment to reducing property prices, reiterated again last night by Premier Wen Jaibao. From the WSJ:

China’s government must resolutely carry out its property-tightening measures with the aim of returning prices to “reasonable levels,” Premier Wen Jiabao said in a speech broadcast Monday.

Mr. Wen’s remarks, delivered in Russia Sunday and shown the next day on Hong Kong-based Phoenix TV, are a reminder that Beijing isn’t letting fears of hurting economic growth cause it to loosen its grip on the sector. A southern Chinese city last week implemented what appears to be the country’s most extreme property-tightening measure.

Lowering property prices is the government’s firm policy, Mr. Wen told an audience of Chinese diplomats and businesspeople during his visit to Russia.

“I will especially stress that there will not be the slightest wavering in China’s property-tightening measures—our target is for prices to return to reasonable levels,” Mr. Wen said. “The property-tightening measures have been ongoing for two years, and some major policies have already been rolled out, especially this year’s construction of 10 million public housing units, which will temper pressure on prices, and slow demand (for private housing).”

…”Housing prices are still in a deadlock, though in the past month we’ve started to see some shakeup in prices,” Mr. Wen said.

Obviously the supply side measures are a boon for iron ore markets but so long as tight monetary conditions prevail I expect the ore market to struggle against a larger tide in the private market.

My second reason is the following chart from the Port Hedland Port Authority and its monthly shipping tonnages of iron ore (assembled in the wee small hours by yours truly):

The chart includes October 2011 figures which, as you can see, hardly budged from spectacular highs.  A few things to note about this chart. Japan and Taiwan have haven’t grown their ore demand since 2006. The ROK is growing steadily. China is…out of control. Whoever said that the commodities boom is based largely on price not volume is obviously not talking about iron ore. Finally, note the counter-cyclical effect of China in 2008. As our other trading partners halved their imports, Chinese demand almost tripled. There is some reassurance in that fact. Nonetheless, I expect demand in the other three North Asian customers to diminish and it is surely inconceivable that China can continue to buy ore at the rate of the last four months amid a slowdown in both its export and fixed asset investment economy.

Ironically, the chart suggests that the best case for iron ore might be that China’s combined slowdown turns unruly, then the monetary spigot will turn fully open.

For now, however, India’s Business Standard likewise sees ongoing insipid demand for steel:

To go by what the vice chairman of China Iron & Steel Association, Zhang Changfu, has said on the subject, the situation is unlikely to get better too soon. He is expecting ore prices to remain weak, with “no demand recovery in sight. After China’s daily steel output remained 1.9 million tonnes for close to nine months, it fell to 1.79 million tonnes in mid-October, with mills finding machine overhaul a better option than adding to steel supply glut.” China apart, Europe, where ArcelorMittal and others have either switched off blast furnaces or postponed commissioning of newly relined ones in view of falling demand for steel, is also held responsible for the debacle in iron ore prices. Now, the ore market will also take its cue from Moody’s paring its outlook for the European steel industry to negative. Moody’s says steel demand in the 27-nation European Union may contract by up to four per cent in the next 12 months, as the region encounters “economic strain and weak construction and auto markets”.

That brings me to my third reason for remaining bearish: that Europe has only begun to slow and will get much worse before it gets better.

So,  if we combine the three observations, we find that Chinese ore demand has hardly fallen at all, authorities remain determined to slow fixed-asset investment and Europe is set to worsen. Yet the ore price has already collapsed. I conclude, therefore, that if a genuine slowing in Chinese demand filters through, which seems likely, we’re going lower.

Comments

  1. I can only but imagine an Australian politician making this statement “Lowering property prices is the government’s firm policy”

    I alsao agree with your ore pricing analysis H&H

    • Australian politicians on both sides have said a close analogue, “making property prices more affordable”, but they’ve only paid lip service to the principle behind that.

  2. At last someone bothers to check the volumes out of PH. All this talk of collapse has thus far been little more than a moderation in pricing which has seen historical highs.

    Pricing decline was approaching rates that are actually uneconomic for Chinese ore producers so that remains a bed of sorts, at least for now.

    Global steel demand is somewhat subdued at present nevertheless production volumes have until very recently been healthy to say the least. And of course China has a plan:
    http://www.hellenicshippingnews.com/index.php?option=com_content&view=article&id=56644:chinas-steel-consumption-to-hit-750-mln-tonnes-by-2015-&catid=16:commodity-news&Itemid=78

    Iron ore and resources are and always will be long term plays, day to day fluctuations are rarely worthy of the time devoted to the machinations of price movements.

    http://moneyland.time.com/2011/06/10/the-worlds-dirtiest-and-best-economic-crystal-ball-iron-ore-yes-iron-ore/

    • Indeed. Their marginal cost of production is about $120-130. Once they are destocked the price should bounce. I don’t think the market is in structural oversupply just yet.

    • 3d1K – surely that would be 2d1K by now?

      You say that iron ore is a long term play. Both Rio and BHP seem unperturbed by the price fluctuation, and they should know what the future demand will be.

      Is there any talk of a cut back in production?

    • Ah, but the difference is when housing moderates 36% many households will be suffering a ‘loss’. When ore moderates 36% miners do not suffer a loss, business as usual.

      ‘Moderate’ would appear to be a fair term.

      • +1.

        a ~30% correction to iron ore has left prices still more than double cash costs.

        The problem is no so much what it means to miners, they are still profitable at much lower prices than current. The problem is what it means to punters who buy (iron ore stocks) high thinking we will have high iron ore prices as far as the eye can see. And we’ve seen in some ibanks analysis that the price extrapolations they have used are, IMO, overly optimistic to say the least (but no doubt, given the reactive nature of forecasting, prices expectations have been slashed recently).

  3. Andy DragoMEMBER

    In other news, “according to the statistics issued by China Iron and Steel Association (CISA), in late October (Oct 21-31), the average daily crude steel output of CISA member steel enterprises amounted to 1.51 million mt, down 3.55 percent from the mid-October (Oct 11-20). In the given period, the average daily crude steel output of all the steelmakers in China totaled 1.72 million mt, decreasing by 4.6 percent compared to the mid-October.” I got this from here: http://www.steelorbis.com/steel-news/latest-news/chinas-daily-crude-steel-output-down-46-percent-in-late-oct-637462.htm
    Declining steel production in China (due to all the reasons H&H mentions) + increased/steady iron ore tonnages from Vale/Rio/BHP (albeit October iron ore exports from Brazil are down somewhat – http://www.bloomberg.com/apps/quote?ticker=BZCMIRON:IND) = continued weakness in iron ore prices.
    With Singapore back from a long weekend today, my bet trading in iron ore will pick up today. Another bet is we can see $10-20/tonne lost this week. The march to $80/tonne by December continues…

      • Andy DragoMEMBER

        You are welcome! There’s plenty more where this came from. I’m waiting for someone at MB to debate the sell-side analysts’ projections of ever increasing steel production and consumption in China. That’s just NOT happening…

      • Andy DragoMEMBER

        Fair point.
        I was actually referring to our friends at Macquarie and today’s comment:
        “China’s Ministry of Industry and Information Technology (MIIT) has announced its expectation that China’s annual crude steel consumption will be on the order of 750mtpa by 2015, as part of the five-year plan for the sector. We believe this growth rate (3.1% CAGR from 2011 levels) is too low for an economy still growing at a high single-digit rate, even with higher inflation expectations. We model 828mtpa of consumption in 2015, a 5.6% CAGR.”
        828mtpa is daily consumption of 2.27 million mt compared to the October figure of 1.79 million mt and YTD 2011 average of circa 1.90 million mt. I wonder what kind of infrastructure stimulus the Macquarie friends are assuming to arrive at 828mtpa consumption.

  4. @3d1k: “Iron ore and resources are and always will be long term plays”

    Can you please elaborate?

    The only long very term data I’ve seen on commodities suggest they’re a very volatile way of achieving a long term real rate of return of approximately zero.

  5. I think 3d1k is just a former property spruikbot re-engineered to boost mining interests!!
    .
    I have heard the Chinese are good at reverse-engineering (aka stealing Intellectual property) – Here is my attempt 🙂
    .
    All this talk of collapse has thus far been little more than a moderation in pricing which has seen historical highs. Pricing decline was approaching rates that are actually uneconomic for property developers so that remains a bed of sorts, at least for now.
    New home sales is somewhat subdued at present nevertheless production volumes have until very recently been healthy to say the least. And of course Property investments are and always will be long term plays, year to year fluctuations are rarely worthy of the time devoted to the machinations of price movements.

  6. So, if we combine the three observations, we find that Chinese ore demand has hardly fallen at all, authorities remain determined to slow fixed-asset investment and Europe is set to worsen. Yet the ore price has already collapsed. I conclude, therefore, that if a genuine slowing in Chinese demand filters through, which seems likely, we’re going lower.

    If demand has hardly fallen then it would suggest supply/demand fundamentals are not driving the fall wouldn’t it? If the market is not responding to fundamentals I’m not sure that you can conclude how it will behave should the current fundamentals change. In other words, as an example, if the current prices are reflecting expectations rather than fundamentals then a decline in demand may already be priced in. etc.

    • Andy DragoMEMBER

      Iron ore market conditions are rare as it’s one market where fundamentals rule and not much financial trading occurs. So supply and demand simply rule the price. So high prices in the first nine months of 2011 are explained by high demand from steel makers and problems in supply on the iron ore mining front (mainly rains in Brazil and Australia early in the year).
      The situation now is reversed: production of iron ore recovered to mines’ nameplate capacity (and a few expansions) while demand is suffering worldwide and more severely in China.
      Links to iron ore supply:
      Brazil exports:
      http://www.bloomberg.com/apps/quote?ticker=BZCMIRON:IND (data through October 2011 available now)
      Australian exports:
      http://www.bloomberg.com/apps/quote?ticker=AUITIROV:IND (data available through August 2011 but based on Rio Tinto’s quarterly production report and Port Hedland statistics through October, my guess is that both September and October 2011 will come in in the 40-41 million mt range)
      Chinese high-frequency steel production data:
      http://www.reuters.com/article/2011/10/27/china-steel-output-idUSL3E7LR11120111027
      And the last ten days of October in this link:
      http://www.steelorbis.com/steel-news/latest-news/chinas-daily-crude-steel-output-down-46-percent-in-late-oct-637462.htm

      If this is not supply and demand fundamentals hard at work, I don’t know what is…

      P.S. India is recovering from monsoons as well: http://www.ssyonline.com/news/ (scroll down to a title “India’s iron ore traffic moving”)

      • I have previously argued along similar lines but as the data shows, there has hardly been a drop in demand yet the price has tanked (tanked meaning sharp drop, the price is still highly profitable for miners). I’m therefore wondering how much influence the swaps market is having.

        The other strange thing to me is that steel makers have made a lot of noise about conditions being bad but gain the data indicates they are not slowing down on iron ore. So is it just empty rhetoric from them?

      • Andy DragoMEMBER

        “there has hardly been a drop in demand”

        There has been a significant drop in demand for iron ore as indicated by high-frequency crude steel output in China. Up until October, Chinese have been pumping out the metal at 1.9 million mt per day. Last ten days of October came in at 1.72.
        The reason port stocks haven’t increased is that a lot more iron ore is floating near Chinese ports waiting to be sold/purchased (and therefore not ending up in the port stockpile statistics).

  7. I’ve marked the last really big inventory cycle in late 2008. As you can see, today’s draw down hardly even registers. So, either this cycle will be small and brief, or it has hardly begun. To my mind the latter is more likely at this stage and I have three reasons.

    w.r.t to the decline in inventories in the latter half of 2008 the context then was steel makers locked into annual contracts amidst a plummeting spot price. They started to reneg on contracts and draw down inventories.

    You also had a collapse in the steel market far greater than anything we’ve seen currently:

    http://static.seekingalpha.com/uploads/2009/12/27/486073-126193113144125-Wildebeest_origin.png

    Because of the different circumstances now vs 2008 it is not clear that inventories should be expected to be drawn down to the same extent.

    Similarly the data shows that when China chose to drawdown inventories in 2008 they simultaneously slowed imports of iron ore (naturally) for reasons above. Until we see a slowing of forward orders/shipments leaving port hedland why should we expect a continued ongoing draw down in inventories?