Texture from Reuters:
Worries about demand for steel products also weighed on iron ore, after U.S. President Donald Trump vowed to slap an additional 10% tariff on $300 billion of Chinese imports from Sept. 1.
…Brazil’s iron ore exports rose 16.6% in July from the previous month to 34.3 million tonnes, the highest in nine months, as Vale resumed production at its largest mine, official data showed on Thursday.
That’s right. It’s over. The charts:
Spot is in free fall. I’m targeting $80 by Q4. $60 is the base case for 2020. And below $50 if the global recession strikes, a very material risk. Paper fell more overnight. Steel is breaking down. Port stocks climbed another 2.3mt last week. They may not get too much further before mills destock!
Following is a note from Vertical Group that very nicely summarises where we’re at:
July iron ore exports out of Brazil rose +16.6% m/m, or the highest level in nine months (Ex. 1), as production at Vale’s largest mine in the state of Minas Gerais (i.e., Brucutu) resumed operations.
More specifically, July’s exports were the highest since October 2018, when Brazil exported 37.2Mmt of iron ore. What caused the gap-up in iron ore prices earlier this year? Well, as our readers are intimately familiar with, the breach of Vale’s tailings dam in Brumadinho, in Minas Gerias, on Jan. 25, led to ~75Mmt/yr of high-end capacity to be taken off line for safety reviews.
That said, in mid-June 2019, Vale was given the greenlight to restart Brucutu, its main mine in Minas Gerais, which boasts capacity of 30Mmt/yr. Furthermore, while Vale is operating at 340-345Mmt/yr currently, it expects to be above this level by year-end, according to Marcello Spinelli (Vale’s executive director of ferrous metal and coal). Encouraging, for the iron ore bears that is, this is the first solid clue from the company that it intends to get capacity back up to the 400Mmt/yr mark since it was forced to halt operations. All in, Vale has revived about 50Mmt/yr of shuttered capacity, and plans to do more.
Exhibit 1: Brazil Iron Ore Exports Boom in July
And, with steel mill profits in China turning negative for the first time since early 2017, steel mills in China are going to be seeking out cheaper source material (i.e., both iron ore and coking coal).
Exhibit 2: Chinese Blast Furnace Steel Mill Profitability
Furthermore, with coking coal prices collapsing nearly 23% since early May (i.e., the other “ingredient” used to make steel in blast furnaces), yet profits still under pressure for Chinese steel mills (i.e., Ex. 2above), we assume steel mills in China are going to demand lower iron ore prices.
Exhibit 3: Coking Coal Prices are Imploding
Yet, despite aggressive stimulus (Ex. 11), China’s manufacturing PMIs are still in contraction.
Exhibit 4: China’s Economy is Still Contracting
And, as would be expected, steel prices in China continue to fall.
Exhibit 5: Chinese HRC and Rebar Prices Continue Falling
And with 67% of the world’s manf. economies in contraction, it seems the perpetual “another source of demand” thesis for iron ore seems a stretch.
Exhibit 6: World PMIs – 67% are in Contraction
Yet, steel inventories in China are on the rise (as seen below, this is clearly an understatement), which is giving traders pause with respect to both forward demand and any hopes of steel prices inverting higher; in fact, as the exhibits below show, one could make the (strong) argument that steel prices in China are about to collapse.
Exhibit 7: Rebar and HRC Inventories in China are Exploding Higher
And, iron ore inventories at China’s ports are also now on the rise, now up 3 weeks in a row (after falling each week since early April)… again… calling into question end-market demand.
Exhibit 8: China Iron Ore Port Inventory
And, with y/y growth in floorspace sold in China still trending negative, it would seem that new starts are likely to fall, which is a key source of demand for steel inside China (China consumes ~90% of the world’s seaborne iron ore – i.e., as goes China, as goes global iron ore prices).
Exhibit 9: Housing Starts “Appear” to be Strong, But Property Transaction Data Suggest this will be Short Lived
Source: National Bureau of Statistics, Vertical Group.
Furthermore, with y/y growth in both excavator sales and loader sales in China trending negative, it would seem that construction activity is indeed in trouble.
Exhibit 10: China Construction Vehicle Sales – %Y/Y
Source: Hong Kong Teng Yuan Co. Ltd., Vertical Group.
And all of this is against a backdrop of heavy stimulus in China recently.
Exhibit 11: China’s Credit Impulse Y/Y% vs. Bloomberg Metals Commodity Index
Note: Credit impulse = (total social financing [net of non-financial equity] + local government debt
issuance) ÷ nominal GDP; all metrics are trailing 12-month.
Source: People’s Bank of China, National Bureau of Statistics, Bloomberg, Vertical Group.
And, finally, these comments, this morning, from our “across the pond” contact in China who trades large quantities of iron ore for, in our contact’s words, the “largest physical market players”: “Iron ore getting slammed so far today, spreads and outrights. Aug we closed 111.70 last night, now 107.60. Front month spreads aug/sept off 0.50-0.60 cents (aug/sept 4.80 marked on close yday, now 4.25). Back end spreads also taking a hit, Q4/cal20 off 0.50 cents also trading 14.75 last. Q4 for your guide we mark at 96.75. Bank seller Q4/cal aggressively. Seeing producer selling spreads into Q1 (want to be long Q1). Chinese also looking to be long same period. Mainly market makers on bid this am. No real axed buyers otherwise. Front is off $4 this morning; we may be seeing the collapse you have been expecting now.”
CONCLUSION: Steel prices are falling in China + steel inventories are rising (sharply) in China + China’s economy is weak despite heavy stimulus efforts + steel mill profits in China have turned negative for the first time in ~2yrs + a lot of high-end Brazilian capacity that was taken out of the market has come back = an imminent drop/collapse in iron ore prices is likely. We would be playing this by shorting Cleveland Cliffs (CLF; SELL; $7.45/shr yr-end 2019 PT) and Fortescue Metals (FMG; SELL; A$5.38/shr yr-end 2019 PT), in that order.