Daily iron ore price update (this goose is cooked)

The ferrous complex continued to deflate Friday as spot was clubbed, paper kept on falling, all of it catching down to steel:

The bubble is bursting. Spot has further to catch up to paper. Steel is also still very high and will fall further through H2.

Nothing has changed for me. We’ll probably deflate some more over the next few weeks, then see strong pricing return through July/August before crashing again in September then rallying into year-end.

It’s hard to be precise about iron ore. It’s very volatile. But I expect prices to halve from the recent peak over a year. From there it should keep on falling as supply returns.

That said, at a certain point it is equally likely that China will slow too much for Chinese authorities’ comfort and they’ll stimulate again, preventing the outright crash back to $40 for a while longer.

But don’t take my word for it. Markets are starting to wake up, via RBC:

China’scredit impulse has turned decidedly negative,and Beijing has reverted to the “deleveraging” policy that predominated pre-pandemic.
Previous deleveraging cycles saw sustained disinflationary pressures emerging in China.
Past deleveraging cycles also saw falling commodity prices, and falling Chinese demand for industrial commodities such as iron ore and copper.
China is thus likely to exert a disinflationary impulse no the global economy just as inflationary pressures arise inNorth America and Europe.
Can there be a global inflationary cycle without Chinese inflation?
The Australian dollar in particular would be a casualty if China’s iron ore demand were to weaken significantly again.

China has been gradually dialing down its stimulus measures enacted to counter the pandemic-driven economic downturn a year ago. Fiscal spending has been curtailed, credit growth has been tightened, and highly-indebted state-owned enterprises have been compelled to default. Beijing has reverted to the“deleveraging” policy that predominated before Covid-19 emerged. The credit impulse has turned decidedly negative at the end of Q1.

Chinese policy tightening is likely to offer a welcome counter disinflationary impetus just as inflationary pressures hit thedeveloped world. Chinese domestic inflation pressures have been weak despite the sizeable runup in wholesale price inflation, and the tightening is likely to keep it so. Consensus forecasts for Chinese CPI inflation is just 1.5%y/y this year, according to Bloomberg, while the IMF is just forecasting 1.2%y/y. But if there are no strong inflation pressures, then why might Beijing be tightening? Now that the economic recovery has advanced, the central government is reverting back to the deleveraging policy that predominated Chinese economic policy debate before the pandemic. The stimulus measures included significant fiscal deficit spending, and the long-term debt concerns have only increased as a result.

As policy has switched towards more “prudent” policy and dialed down credit provision, we have been witnessing sequential weakening in growth recently. The blockbuster 18.3%y/y GDP growth rate in the first quarter was flattered by extremely favourable base effects. Quarter-on-quarter growth in fact slipped in Q1 2021 to 0.6% q/q from 3.2% previously.

Previous periods of sustained deleveraging, such as the one between mid-2013 and mid-2015, and the one in 2018, saw widespread disinflationary pressures emerging. Headline CPI at the end of both deleveraging cycles had dropped well under 2% y/y. Both Chinese headline and core CPI rates are under 1% as of the latest April 2021 reading. Can there be a global inflationary cycle without Chinese inflation? Beyond disinflationary pressures, sustained deleveraging is expected to reduce Chinese demand for global commodities. Again, if we look at the periods of the two most recent deleveraging cycles,t here were sustained downturns in commodity prices. Given the uncertain lags in the impact on commodity prices from the deleveraging cycles, let us look at the changes in the CRB spot commodity index both over the same time period, and using 6-month lags.

We could also look at the Chinese import data of selected industrial commodities to gauge the direct changes to Chinese demand during the deleveraging cycles. Below charts show the y/y change in the volumes of iron ore and copper ore imports respectively. The y/y changes are based on 6-month average import data as of each month, and shifted back by six months to account for the lagged impact of the deleveraging cycle.

It is again obvious that the deleveraging cycles of 2013-2015and 2018 coincided with a marked weakening of Chinese demand for the key industrial commodities of iron ore and copper.Thus, Chinese deleveraging is occurring at a point when there is widespread market bullishness about a “commodity supercycle” driven by the global growth recovery.That said, demand and supply dynamics do differ significantly across various commodities. The current supply difficulties in global copper production, for example, may support prices so long as Chinese demand does not collapse. The iron ore market is arguably better balanced, and may therefore be more vulnerable to moderately weaker Chinese demand. China accounts for approximately two-thirds of global iron ore imports.

Conclusion

China’s credit impulse has turned decidedly negative in recent months. Statements from policymakers have consistently emphasised the need to shift towards “prudent” policy, which means less stimulus, and a reversion to the pre-pandemic deleveraging policy. The turn back towards deleveraging has already reduced China’s sequential quarter-on-quarter growth momentum. Historically, sustained deleveraging cycles have unleashed disinflationary pressures in China, as in 2013-2015 and 2018when headline CPI fell under 2% y/y at the end of both cycles. Current Chinese headline and core CPI inflation are runningunder 1%, so we may expect continued muted domestic inflation now that a new deleveraging cycle is underway. Previous develeraging cycles also exerted negative pressures on global commodity prices. Chinese import data confirmed marked drops in imports of industrial commodities such as iron ore and copper during previous cycles. Consequently, the start of a new sustained deleveraging cycle in China may be expected to undercut the inflationary pressures arising from the US and European economic rebounds. It is difficult to parse the net effect on global inflationgiven the various countervailing forces at work. Nonetheless, China is likely to exert a disinflationary impulse on the global economy through a combination of expected growth moderation and weaker commodities demand. A likely more directly negative impact is on those commodities where Chinese demand is crucial, and iron ore is an obvious one. In this regard, the Australian dollar is likely to face headwinds amid an anticipated downturn in Chinese iron ore demand.

Barring another Vale accident (always possible) this goose is cooked.

David Llewellyn-Smith
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