Iron ore price weakness set to resume

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:

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:


David Llewellyn-Smith
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  1. The market really only focuses on one or two themes at a time. The dominant narrative in recent weeks has been CB action: EZ bran nue dae! and QE3. The Aussie started slowly bleeding in response to falling commodity prices, but reversed almost the entire down move in a few sessions when it became clear serious CB interventions were on the cards. This illustrates the dominant theme.

    I’m sceptical that OMT will be as bullish for risk as LTRO, seeing as it isn’t OMPrinting, but we’ll see.

    The crucial question for the Aussie is how hard will the USD fall if QE3 arrives tomorrow morning? My view has been that the simple threat of QE3 has prevented any major AUD down move because a sizeable fall would just provide space for a sizeable rally when QE3 was announced, so traders aren’t letting it go. Plus with the RBA still coy about rate cuts I haven’t been able to justify shorting it heavily yet. Once (if) QE3 is announced though, and that hurdle is cleared, I would expect the market’s attention to shift to China with real commitment (how high it goes off the announcement is anyone’s guess, but August’s highs look within reach). US monetary policy has been able to dominate the China slowdown, but I believe once QE3 is in place and no longer something traders are hoping for, fundamental pressure out of China will weigh much more meaningfully on the Aussie.