The long term price of iron ore

Here is today’s iron ore update:

Hints of stabilisation on Friday but it’s still anyone’s guess if this is the bottom. I’m pretty skeptical so long as Chinese steel prices are still falling.

Meanwhile my views on iron ore have been perfectly captured in a note by Ric Deverell, the widely respected head of commodities at Credit Suisse via FTAlphaville:

Our feeling is that the current adjustment is in large part a move to a lower trading range:  In trend terms, global steel production looks to be increasing now at around a 2.5% p.a., while seaborne exports of iron ore continue to grow at an 8% p.a. pace.

With global growth momentum weak, and China’s steel demand having moderated, we now believe that the opportunity for a return to a market in shortfall has diminished.

It is worth noting, however, that markets tend to overshoot to the downside during dramatic events. Given the cuts to Chinese production under way, and a “buyer’s strike” by mills, while the risk in the near term is for further falls, we expect prices to rebound to around  US$100 in Q4, before slowly eroding towards longer-run averages over subsequent years.

Importantly, however, we consider it most unlikely that prices settle anywhere near the historically low levels seen in the early 2000s, which we  feel will prove to be the historical outlier.

While a bounce is likely, the assumed stabilization will need a substantial reduction in Chinese iron ore production, as well as some recovery in steel production  as the stimulus feeds through. Absent both of  these factors, prices could still surprise to the downside.

…Further stagnation in demand could still see a retreat, albeit temporarily, below the US$80, the long-term historical price average.

I personally see the ultimate equilibrium point a little lower but the argument is exactly right. China and steel can grow fine, our terms of trade can remain historically high and Australia will still need to find a new equilibrium of its own.

David Llewellyn-Smith
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Comments

  1. GunnamattaMEMBER

    I have just done a report on Russia steelmakers which indicated much the same. There has been massive overproduction until quite late this year (July at least for China, US and Russia – when production was still growing). There are definite signs it fell in August.

    ‘….. are seeing signs that a gradual reduction in global steel output in August is putting pressure on raw material prices. The price of iron ore deliveries to China has fallen by nearly 20% in just four weeks to around $95/t.

    Lower raw material prices are another benefit of disciplined production: cutting output reduces demand for iron ore and coking coal, bringing their prices down and allowing steelmakers to restore some of their lost margins. However, given that production cuts have so far been largely superficial (insufficient to make a dent in raw material demand, in our view), we doubt that input costs will stay low long enough to allow steelmaker margins to recover to meaningful levels.’

    The over production angle is being largely driven by politics in China, and that sparked a jump in Chinese steel exports from about February this year. Other over production is largely being driven by the structure of many of the big steelmakers – which in some case seem happy to have negative EBITDA from mining segments. A fair bit of positioning for a rebound in demand that nobody is seeing anywhere yet.

    The other thing being noted is movement on the Value Chain split – where raw material producers have seriously taken over a chunk of the margin once going to steel producers – with everyone basically in agreement that raw material producers will be handing some/most of that back.

  2. I can’t see 2% growth in steel output going forward. Europe is slashing spending, the US is about to hit a fiscal cliff, Chinese mills are cutting production, Japan’s economy is slowing and south Korea too.

    Chinese steel consumption was always unsustainable and you can see that in ghost cities, underused rail, bridges to nowhere and trophy government buildings. That is now ending.

    Global steel consumption will be lucky to stay positive. I think most likely it will decline.

  3. Exhibit#1 — everyone has charts like that but with those 100 year price charts the result you get is heavily dependent on the deflator you choose. The confidence interval for this stuff is pretty wide so referring to an historical mean in a context of some kind of eventual mean reversion is pretty shaky given the uncertainties.

    But in any case — and this applies to all such charts not just iron ore — why should there be a mean real price (for reversion)? Shouldn’t the reversion be to a mean real margin?

    • I agree, the cost base since the 1990’s has risen significantly particularly the XR (50cents to $1 now to the USD has a big impact), not to mention oil at $100/bbl, wages, steel cost (steel price got down to the low $200’s now >$500/t), so historical price series don’t tell me a lot. I can remember the big well know low cost mines in Brazil and WA at $5/t in the 1990’s !

      • The Mighty Pilbara #6 – RIO`s Yandi mine

        “Both the Yandi mines are the most profitable in the portfolio of BHP and RIO iron ore mines. As a rough guide, mining costs $6 per tonne, railing it to the port $2 per tonne, loading at the port $1 per tonne and shipping it to China or Japan $12 per tonne. With 50 million tonnes per annum, at an average price of $100 per tonne (or pick your own number), this is nice business to be in, even allowing for substantial capital costs. This is partly because the overburden is very thin at Yandi and also because processing is as efficient as possible.”

        http://www.henrythornton.com/blog.asp?blog_id=2393

        • More recently there was a weekend dash in a business mogol’s personal jet,….. blah blah blah.. This visit, accompanied by Mrs Thornton and in a party of four, the other members of which included mining legend Malcolm X and his charming missus, Liz X, was to be Henry’s third and possibly final visit.

          You want us to rely on the words of a freeloader cum sycophant???

          Pull the other one, MineBot.

      • If the rise in costs is partly due to the mining boom and the rising Australian dollar leading to higher wages, wouldn’t we expect lower costs as the this reverses?

        Once there is a perception that the boom is over and we are settling into a new equilibrium between supply and demand, you’d think we would see a lower Aussie dollar and less competition for staff and resources, and lower steel prices (due to a global glut) which should allow Australian miners to reduce costs in US dollar terms.

  4. “Iron ore prices have averaged $80 a tonne US in real terms for most of this century”

    Are you able to explain what they mean exactly H&H? This seems to suggest that the entire span of the long-term charts I have veiwed – the past 30 years – is some kind of abnormally low period and where prices are now is roughly normal.

    I’m not sure I quite buy it.

      • Hmm – strange that prices of a material that is a basic building block of modern civillization have trended down in big steps over more than a hundred years. Surely the demand for it has only been increasing in general all that time?

        I see that prices actually rose during the great depression when demand must have been falling. Maybe frightened investors flocked to iron ore in those days.

        Seriously, if we take this piece of information on face value, I think the question is WHY did prices of something so fundamental nosedive for 30 years? I don’t recall a three decade long depression during that time. I take it that major new discoveries must have been made and major new supply must have been coming on line or something.

        Which is what has been happening these few recent years. Just in time for the ending of the greatest steel bubble in history.

        • Not that it covers the full period, but from 1990 after the USSR imploded there was a lot of new production available to the open market for all sorts of commodities and base metals.

          • A good point.

            Perhaps extraction methods and technology were becoming rapidly more efficient over that time as well, allowing for output to increase more quickly than in the immediate postwar years?

          • Lef-tee,

            Don’t underestimate the adaptability of the Russian Mafia and their business acumen in providing new/increased production. In early 90’s Russia they were pretty much the only organisation that actually functioned.

            All those export dollars from commodity sales were hugely lucrative to very few agents.

        • Price may have trended down over the 20th century but how did real margins trend? (or alternatively how did real cash cost trend)

          These guys presumably have the resources to make a good estimate of these things but it seems they gathered some easy data and put this together while eating a sandwich over lunch.

          • I do have to say, a 30 year long downtrend is the biggest “historical outlier” I have ever seen.

            I think the so-called outlier might be driven by structural changes increasing capacity. The first big downtrend beginning in the late 1800’s was probably driven in part at least by the advent of huge, powerful mining machinery replacing human and animal muscle power. If that’s the case, why should any falls settle at around the mean last seen in about 1975?

            Absent any more stimulus, why can’t prices revert back to their GFC-eve level of around $60? Is it inconcievable that they could settle and plateau at $50 or less when in terms of todays dollars, it traded at $15 to $20 dollars for the previous 30 years?

  5. Wouldn’t it be just tragic to see the ore price overshoot on the downside to those historical outlier levels, just as Gina and Twiggy are trying to get their new mines developed?

    • Yes it would be tragic. Just like it would be tragic for anyone to lose or fail on any business venture.

      You have areal chip on your shoulder. Now move on.

      • I would feel sorry for any of Gina’s employees who found themselves out of work. I’ve never had a soft spot for mining magnates but after the comments made by Gina (who inherited a fortune from her father) about the poor and disadvantaged, I’d be happy to see Gina herself take a bath.

    • GunnamattaMEMBER

      I could think of more tragic things, like depriving a future generation of Australians a viable housing/employment basis just to see a batch of right wing oligarchs get rich and brag on about how little tax they pay/secession/employee rights etc etc etc …………….

      • I could think of even more tragic things. Like entreprenuers and mining companies get fed up of being bashed and scammed by Left Wing union dominated minority Govts along with their compliant press and decide to sit pat for several years not investing and reducing their workforces. Thus causing widespread unemployment and mortgage stress. That negative Business environment is seen by overseas investors who then do likewise adding to the worsening situation.

        Do yourself a favour Gunna. Go and talk to any of the hundreds of thousands of mine workers , contractors and support workers in the cities (and their kids, parents and communities) and convince them with your informed arguments that it would be so great for them if their right wing oligarch employers go belly up.

        • GunnamattaMEMBER

          Mate, shouldnt you be over blogging on the Andrew Bolt page or somewhere in New Ltd land?

          And as for….

          ‘being bashed and scammed by Left Wing union dominated minority Govts along with their compliant press’

          I am not sure where you have ever seen that, but the thought of it is providing all of us in the office a good chuckle.

          …..yes that feral left winger Gillard and her collection of soft on apparatchiks is just a heart beat away from Trotsky – well spoted (not)

          • So MB is reserved for left wingers ONLY then? Thanks for clearing that up.

            Maybe thats the problem Gunna. Too much time in the office chuckling and gossiping around the coffee machine,meanwhile out in the real world….

            Where have I seen that?

            The Age.
            SMH
            our ABC… a few, unless you happen to be blind of course.

            Broaden your reading mate. Look up the Fabian Society, who they are, their members and how they operate. You may spot some things that even you could recognise.

          • GunnamattaMEMBER

            Cheers GSM,

            some people might have looked at your earlier post and thought you had a point.

            But after looking at that gem they will slot you under the right wing loss leader category and start hedging any credibility thay may have felt inclined to bestow upon you.

            keep up the good work…..

        • Well said GSM.

          ps Nice to see you gave Gunna and his colleagues at Green Left weekly a bit of a laugh… 🙂

          • GunnamattaMEMBER

            Believe it or not mate I work for an investment bank (usually remotely but some of the team are here in Geelong with me today – where it is nice and sunny).

            And the chuckles they are having revolve around how insanely crazed a society (or neanderthal is the word being tossed around by one) must be to fry its import competing/exporting sectors on the altar of mining.

            Then there is the thought of ‘well maybe the great Oz could be shorted – how best to do it?’

          • “..I work for an investment bank ”

            Your one of the fortunate lot making lashings of money (from the comfort of being short or long on an office keyboard) no matter how much sufferring there is in the real economy. That then explains why throwaway comments expressing concern about “depriving a future generation of Australians employment…” etc come so easy.

            Short the AUD? Sell 2mill AUD market; Enter trailing stop 40 pips- GTC. There you go. Takes some cajones, mind.

            🙂

          • how insanely crazed a society … must be to fry its import competing/exporting sectors on the altar of mining.

            Nice to know someone is here taking on the MineBots while I’m away.

            BTW, I didn’t notice the MineBots showing much sympathy for the thousands of displaced workers adjusted out of a job during the boom. I was simply told it wasn’t happening, and if it was happening, we couldn’t do anything about it anyway.

          • 1. Not successfully. A rant like Gunna’s indicates a spelling error in alleged profession… Those in investment banking rarely impress with societal concerns beyond personal bonus targets.

            2. This Minebot has always expressed sympathy for those made unemployed, regardless of sector (even PS!) but official unemployment figures do not support significant uptick in unemployment levels to date – perhaps indicating ability for most to secure alternative employment.