What can a century of iron ore prices tell us?

Given the equity market continues to price the future of major iron ore miners as if we are facing just another cyclical downturn, today I take a look at the iron ore price over the very long term in search of answers. Here is the nominal price of iron ore for the entire twentieth century sourced from the US Geological Survey:

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No real surprises there. The price was falling following the 1890s boom entering the century, then spiked briefly in the aftermath of the Great Depression, presumably as stimulus built stuff all over, then powered through post-war reconstruction and took off in the Japanese boom. It’s all a lot more obvious in the real price chart, which I’ve deflated using the US CPI:

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Amazing chart, really. Note that it is a yearly chart and the 2014 price average is still $99. Next year it will be more like $70 and the crash will be much more complete. The China boom is huge but perhaps not as out of proportion with the Japanese boom as some might expect. The China boom took off much more quickly and appears, proportionately, to be over more swiftly as well. The year on year growth chart shows the greater volatility nicely:

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The 114 year average real price is $60, suggesting that that is where we’re heading back to now, but not before we repeat the experience of the post Japanese boom years and sink well below the average for an extended period of time. A more gloomy assessment might see a real iron ore equilibrium price somewhere around $50. Whether temporary or permanent, it’s hard not to conclude that we’ll find the ultimate bottom somewhere at or below $50 in this cycle.

BHP and RIO may have fooled others (and themselves) into thinking that they are in control of this shakeout but history says otherwise.

The best explanation I’ve heard for these boom/bust cycles is that when construction booms create steel and iron ore booms they exaggerate their own demand. It takes vast amounts of steel to build the furnaces, mines, railways and ships that drive steel production growth. That fools producers into massive expansions and when the underlying construction pulse eases, the virtuous cycle of steel industry expansion reverses and huge overcapacity emerges.

The hundreds of millions of tonnes of potential steel output currently idle in China is an example. Steel prices sink to paralytic lows and mills jam those collapsed margins into their supply chains. As steel margins improve each time and production rises, oversupply hits again and prices tumble once more, forcing further deflation into the supply chain. The entire price deck of the steel and iron ore industries shunts repeatedly lower to the marginal cost producer in both.

The hundred year history of iron ore prices suggests that we have only just begun this wrenching, value annihilating process.

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