Credit Suisse optimists see H2 sub $100 iron ore

Credit Suisse has a new note out on iron ore this morning that I agree with as an optimistic scenario for iron ore. First it sees the current breakneck pace of Chinese steel production to slow:

• Housing and construction activity already show signs of leveling out, not least because price inflation continues to bug Beijing and we expect further measures will be taken to keep price rises under control. The most recent price increases for new homes will most likely mean that Beijing will retain strict property controls, even if this drags on economic growth in H2.
• Infrastructure activity will experience a phase shift lower from a seasonally-strong Q2 as investment activity rolls off over the summer months. However, the impact on steel use will likely continue to be ‘lumpy’, reflecting lags in translating capital flows into physical action. Not all of this activity is highly steel intensive.
• The capital goods sector will likely continue to suffer constrained growth in part due to moderating construction and infrastructure activity, but also as a function of overall flatter growth in core manufacturing; this means that running off overhangs of unsold goods has taken far longer than expected.
• Steel Inventories have surged since Q1. These comprise not only stocks of steel products in the hands of traders, but also reported inventories of finished steel at steel mills. As order books start to contract (we are picking up reports of orders starting to shrink back beyond May/June), mills are likely to undertake a phase of destocking, a move that would be precipitated by fears of falling steel prices.

I note that Credit Suisse is still pretty bullish on Chinese steel production growth, seeing it continuing at 4-5% through 2016. But that won’t save iron ore:

In terms of the degree of change in China’s steel production, Q1 output of 191.7 Mt, overshot our forecast of 189 Mt. We next expect Q2 output of 197 Mt, as mills begin to slow in June, causing runs to retreat from current quarterly rates of around 199 Mt.

A steady seasonal decline from there through Q3 and Q4 would translate into crude steel production of 187 Mt and 180 Mt, respectively. Quarterly iron ore demand is therefore likely to be around 288 Mt in Q4, down from 307 Mt in Q1. At the same time, domestic iron ore availability should amount to 94 Mt, against 75.6 Mt in Q1 and seaborne supply should
be more than 40 Mt higher.

In sum, Q4 should present a market roughly 75 Mt looser than just experienced in Q1. In consequence, we believe iron ore prices will maintain their recent move lower, tracking down towards where Shanghai rebar is already trading.

By my calculations, the Q4 seaborne market will be closer to 100 million tonnes better supplied than Q1 and that assumes no return of Indian ore. Against that we can weigh the lower port stocks in China which means any Chinese mill destock is likely to be less severe on prices so long as it does not involve an economic freeze.

Basically, this is the optimistic scenario in which iron ore bleeds towards then below $100 across the second half. Then lower again next year.