HSBC confirms the iron ore bust is here

Here is yesterday’s iron ore price table with a nice bounce across the complex on whatever trivia blew in:

But that’s where the good news ends. HSBC yesterday released its quarterly commodities update and iron ore took a pounding, with forecast prices for 2013 falling 27% to $105. It is not a relief exactly, but it is nice I suppose, to find a respected bank finally following my thoughts on the future of the iron ore price. The HSBC rationale was rock-solid:

Our major single change in this review is in iron ore prices, where we cut our 2013 forecasts by 27% to USD105/t, which we believe is below consensus. This is partly due to poor demand conditions, but also because we now question the consensus view of marginal costs at USD120-130/t. We have been careful to consider a consistent group of outcomes – and are cutting capex, supply growth and cost inflation for the iron ore majors. We do not believe the industry will use leverage to fund organic growth, so the swing factor is now clearly capex, which in our view has peaked.

Kaching! In short, either way, whether it’s price or volume or both, the boom is busted. They go on:

We have lowered our price forecasts and considered the impact on cash generation – for many producers, the cut from USD130 to USD105 will approximately halve operational cash generation and must, therefore, impact capital spending considerations. We have cut our supply assumptions for all the majors, partly due to this but also due to company specific factors (eg pushing out Minas Rio yet another year).

• We think cUSD100/t prices will continue to deter marginal investment in the west, and see the pullback in Q3 by FMG from its growth plans as a precursor to more restraint by junior producers in Australia, where currency pressures remain an issue, and Africa.
• We have cut our forecast for production growth in 2013 from 5% to 4% (down from our April estimate of 8%).

Moreover, the assumptions underpinning these forecasts are still more bullish than my own:

We have cut our estimates of global crude steel production growth from 2.9% to 2.4% in 2012, and from 3.5% to 2.1% in 2013. This reflects a period of contracting demand in Europe and a cyclical slowing in China.

• We do not believe that this is sign of a structural change, and expect growth to return to 3.5-4% post 2013. Although our fieldwork in China confirmed that demand and confidence was poor, we still see significant structural upside due to ongoing urbanisation, particularly away from developed costal areas. We continue to see installed steel in China representing only c4t/capita, vs 14t in the US and 18t in Japan.
• We expect demand growth for iron ore to reach just 2% in 2013, down from 4% in our last review. This will be the lowest level of demand growth since the 2008/9 financial crisis.

They may not want to say so, but that chart looks like a structural shift to me, down from trend growth in demand near 10% to under 5%. Still, HSBC’s assumptions for growth in global steel demand remain around 4% per annum, driven largely by 5% per annum growth in Chinese output. My own view is that as China shifts its growth drivers, the risks are all to the downside of these figures. My base case for growth rates is roughly half those of HSBC.

The next sacred cow to be slaughtered by HSBC is the “price floor”:

Iron ore is searching for a new equilibrium price – one that incentivises some production growth in the west and keeps some high-cost mines operating in China. We have focussed on this latter point recently (see our corresponding sector note today What is the iron ore price telling us? Changing our view) and increasingly question the consensus assumption about the amount of ore in the supply chain that is genuinely high cost. We acknowledge that there is very little fundamental data on this issue, and there is now more upside than downside risks to our forecasts.

• We do think that the reaction of marginal producers in Australia and China indicate that there is a firmer floor at 90-100/t than at 130/t. We believe that for prices to average below USD90/t, demand would have to begin to contract globally.

Exactly. The bank now has a long term forecast of $88 for iron ore.

All still slightly on the bullish side in my view but very much confirming my base case. HSBC was more bullish on coking coal, expecting a rebound to $200. I don’t see that coming. It will track iron ore. There is surplus supply in that market as well. Thermal they see remaining at current busted levels.

For Australia this comes three years too early. It will mean very large current account deficits while we wait for LNG exports to come on stream in a big way in 2015. It means the notion of volume growth driving the net-exports component of GDP for the next three years is very weak. It means consistent pressure on the national and commodity state budgets. It means lower interest rates for longer and, if housing is triggered as the alternative growth vehicle, a huge current account deficit within eighteen months.

I don’t often agree with Marius Kloppers. But today I do. We need a national hair shirt.

121017 Metals Quarterly Q4 2012 (1)