Yesterday ANZ had an interesting conference call about iron ore, China and Australia. The economic legs were all a bit sunny and happy but the iron ore dimension was very good:
2. MARK PERVAN, HEAD OF COMMODITY RESEARCH
Thoughts from China
- General mood very cautious, key export province Guangdong seeing activity down as much as 40% – most believe it could be another 6-9 months before things improve
- Recent stimulus initiatives won’t be felt on the ground (in the market) until 2Q13. Many waiting for new government officials to outline new policy/growth agenda’s.
- A key dynamic, has been the inelastic steel supply response to falling prices. Reports suggest steel output is 15% above required demand (Figure 1)
- Main issue around sticky supply is political factors driving high SOE output – wanting to keep social stability until the new leadership change-over towards the end of the year
- Margins for smaller mills have also improved because of fast falling coking coal and iron ore prices, more than offsetting weaker steel prices.
- Unsold production is being stockpiled on the hope of selling at a later date. Accordingly, steel stocks are at very high levels which will create a supply overhang until demand improves.
- Steel mills are also working closely together to push prices lower. Press reports that China steel production has peaked looks more like posturing to keep sentiment weak rather than a fundamental view.
- Many believe mills will stay actively out of the market until mid October – after the week-long National holidays in the first week.
- Accentuating iron ore price weakness is rampant shorting of Chinese steel prices – now at record high open interest (Figure 2). Some believe iron could go as low as USD80/t before recovering (in a relief rally) back up towards USD100-110/t by year end
- Ultimately, prices look oversold. As sentiment improves prices will recover back up to the USD100-110 range.
- However, we think pricing power may be more balanced going forward, with steel mills rightly restoring better profit margins from unsustainably low levels over the past 2-3 years – prices in the USD110-130, instead of the USD130-150 range.
In short, one ugly picture. And not one, in my view, that justifies the final statement unless a lot of iron ore production comes out and a lot more iron production plans are pulled back, including here.
To today’s prices and the recent squeeze ran out of puff yesterday: