From Goldman Sachs, here is a nice summary of the unwind we are seeing in the iron ore price owing to liquidating port stocks:
Traders and small mills lie behind the inventory puzzle
In principle, a combination of tight credit conditions, subdued steel demand and diminishing concerns regarding security of supply should incentivize Chinese steel mills to keep iron ore inventories at a low level. It is therefore puzzling to see iron ore stocks at Chinese ports increasing…
Financing deals emerge amid tight credit conditions
According to market sources, traders and steel mills alike have engaged in financing deals that tie up inventory at the port. Traders can use a letter of credit to buy iron ore from a producer, but the transfer of title from the trader to the steel mill may be delayed at the mill’s request. Importantly, we believe that some steel mills have engaged in financing deals in their own right, in effect playing the role of a trader rather than that of an enduser. Disappointing steel demand and the recent focus on air pollution have impacted production rates, thereby freeing more inventory for trading/financing activities. In some cases, the difficulty in securing bank loans directly may drive traders and mills to use iron ore stocks as collateral for loans from 3rd parties.
In either case, falling iron ore prices (down 12% ytd) and limited storage space are likely to increase the pressure on traders to sell, but steel mills may be waiting for the market to hit bottom before buying.
As I said earlier, once this is underway it takes on a life of its own as collateral values fall driving more sales, lower prices and collateral values…
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
