Goldman: Iron ore price to crash

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Don’t say you weren’t warned. From Goldman:

Early signs of a structural surplus are already evident 
The first quarter of the year usually sees weather related disruptions to iron ore supply and an increase in demand from the Chinese steel sector; this year, iron ore prices have fallen by 21% while Chinese port stocks have increased to a record 109Mt. The market has therefore started the second quarter with an inventory overhang and with limited upside in demand for the rest of the year, while the upward momentum in seaborne supply continues. We believe the structural surplus will become increasingly pronounced during the current quarter and going into 2H 2014.

Lower prices are required to force marginal supply out 
We forecast a seaborne surplus of c.77Mt in 2014, rising to c.145Mt in 2015. Lower seaborne prices will eventually impact Chinese domestic prices, forcing the closure of marginal supply coming mainly from small mines near the coast and fully exposed to competition from imports; this time, we expect these closures to be permanent. However, we believe the market continues to underestimate the level of competition implied by the growing divergence between Chinese demand and seaborne supply.

The time to test the Chinese cost curve is near 
The level of cost support that high cost mines in China will provide when the market shifts into structural oversupply has not been properly tested yet; the correction in 2H 2012 was too brief to indicate how Chinese producers will respond this time. Partly for that reason, a wide gap in expectations persists: industry sources in China believe domestic supply will expand further while market participants ex-China forecast Chinese mine closures on a large scale. In our view, the scale of closures will be relatively limited because a) closures of small mines in coastal areas will be partially offset by new projects in both coastal and inland regions, and b) the Chinese iron ore sector will strive to improve its competitiveness via increased mechanization and higher productivity. On that basis, we continue to argue that the Chinese cost curve will not prevent seaborne iron ore prices from crashing through the US$100/t level going into 2015.

I can only add that Goldman is forecasting an $80 average price for 2015, which implies dips to $65 around inventory cycles…

David Llewellyn-Smith

Comments

  1. Predicated on demand being roughly similar. Land sales to developers slumped 78% Jan > April as unsold inventory climbed 30%

    • And that is the critical bit… IB’s always look at supply because it can be analysed to the 10th degree. Companies put out statements of how many tonnes they will produce, and what their expansion plans are. C1 costs calculated. Who are the new entrants, will they get funding etc, etc. Transport distances, shipping rates, etc. Understand however, its all white noise – supply is, and always will be, the first derivative of demand. It in itself, is always a lagging indicator.

      The really important part is demand – which conversely receives scant analysis. As a general rule, IB’s just assume a demand linear growth curve – with some macro analysis suggesting backing this view.

      If you want to really want macro commodity analysis from he demand perspective, you can’t, and you won’t get it from the IB’s. It unfortunately is more ethereal, and deals with lessons/relationships learnt via economic history. It relies on good data collection. And this is the difficulty/crux of its short-coming in this situation, because there has never been a type-“China” demand before since the Pharaoh’s.

      Another problem that most people don’t get is that Chinese economic statistics are based on Productive Activity (similar along the lines of Cuba and North Korea), as opposed to Expenditure Growth, which typically forms the basis for Western GDP calculations. The underlying premise for a productivity based reporting system is that supply will in turn create demand. Hence the attractiveness to the Chinese government in building the Great Wall of over-capacity, because it assumes that whatever good is produced, it will be consumed at some point in the future.

      Thought about this subject for a long time and I am not sure what the answer is… I just know that all the cost curves in the world will not save iron ore when demand tips over, I think it will be housing that will trigger a banking crisis (yes – banking). I think the Chinese will protect their own iron ore production profile for a five or six year period (see previous post – they have to for employment reasons). Although much of this construction may seem extremely wasteful, it could mark a necessary phase in China’s development, as the country inevitably climbs up the value-added chain. High-tech goods now account for 36.5% (HSBC – although their US high-tech exports number looks way too low) of total export sales, up from 6.5% in 2000.

  2. Western Australia’ s budget surplus rests on iron ore at $122 a tonne and they project $49 million change per dollar up or down.
    The 175 million dollar surplus would seem a pipe dream and the credit rating already on shaky ground.

  3. WA budget price assumption $US /tonne:

    2014-15 = 122.7
    2015-16 = 120.1

    Bureau of Resources and Energy Economics (BREE) estimates:

    2014 = 110
    2015 = 103

    No wonder falling iron ore prices are keeping Mike Nahan up at night, as WA now relies on mining royalties for 22% of its total government revenue.

  4. Schadenfreude

    I can only add that Goldman is forecasting an $80 average price for 2015, which implies dips to $65 around inventory cycles…

    Has anyone seen Twiggy buying any ‘White King’ in bulk….?

    He must be getting skiddish with those forcasts… 😈

  5. does foolme sachs know that the FE of chinese iron ore is 14 pct on average ?

    its 300 million tonnes of eqivalent overseas DSO to make up for the higher cost curve fall off

    oz and brz miners cant wait for usd 80 per dmt

    question remain will the media put focus on the negativity for the domestic chinese
    iron ore production ?

    I doubt it