Via the excellent Damien Boey at Credit Suisse:
Today, we have seen the Dalian iron ore futures price fall by almost 6%. Many have been expecting a pullback in prices, as supply side pressures ease. But is there more to the iron ore price story than just a supply side squeeze? After all, one could easily make the case that financial demand chasing late cycle inflation and uncertainty hedges such as gold and oil have been surprisingly strong this year.
To be sure, iron ore and base metals prices are far more cyclical than gold and oil prices. We would expect them to fall in the event that world and emerging market growth slow below a trend pace. And we have seen such a slowing recently. But if we told you last year that the commodities complex as a whole would “hold up” heading into an escalating trade war, we would not have been taken very seriously. We, and the street have been surprised by the resilience, and in some cases, strength of commodity prices all things considered. Something appears to be different this time around.
On the cyclical side of things, we make the observation that the single best leading indicator of iron ore prices is the rate of change in Chinese property demand (floor space sold) relative to supply (floor space completed). Supply growth does correlate contemporaneously with iron ore price inflation, and demand growth does lead supply growth. But we find that the relativity is actually what gives us the best leading signal. Recently, we have seen demand shrink by 1.8% in the year-to-2Q, and supply shrink by 16.5%. These numbers look very bearish for iron ore prices in the short-term, especially given that prices have risen against the grain of the Chinese property market due to (iron ore) supply side factors. However, the relative growth rate is actually quite positive (+14.7%). This foreshadows strength in iron ore prices in the coming quarters – not weakness.
Again, to be sure, a lull in price action should be expected because earlier in 2019, the Chinese property demand-to-supply balance to deteriorate slightly. But prices seem to have overshot the mark in 2019, partly because they undershot so badly in 2017-18. And looking ahead, we are not staring in the face of weak Chinese fundamentals.
A contrarian buying opportunity as some investors sell on bubble popping fears?
I normally agree with Mr Boey but not this time. Iron ore is big, fat short on deteriorating fundamentals.