Commodities | May 06 2014
-Inventory unwinding not dramatic
-India consuming most of its iron ore
-Australia's iron ore exports rise sharply
-Chinese property and impact of a downturn
By Eva Brocklehurst
Some analysts think the 10% drop in the iron ore price in the past two weeks is overdone. Contributing to the fall were reports of the Chinese cracking down on inventory financing of iron ore and the partial reinstatement of exports from India.
With the onset of stronger seasonal demand and additional Chinese stimulus, ANZ Bank analysts expect iron ore prices to rebound back to US$115-120/t over coming months. Recent news featured China's local banking regulator informing banks that deposit requirements on letters of credit for importing iron ore were to be increased. The notice appears to the analysts to be aimed at reducing the level of bank loans supported by collateral that uses letters of credit and inventory. Inventory financing is popular among steel mills which struggle to acquire more traditional forms of debt and this has resulted in port stocks rising to record levels. The analysts think the impact is overstated. The current stockpiles only equate to the previous 5-year average of six weeks supply, well off the record of nine weeks seen in 2008.
The other event in the news was the partial reversal of the mining ban in Goa, India. Goa can resume mining and export of iron ore. The policy reversal is not expected to have a great bearing on global supply. Much of the ore is expected to be consumed in India and is of low quality and grades which the Chinese have already started to move away from because of environmental concerns. The ANZ analysts do not think a drop in the iron ore price below US$100/t is likely.
Macquarie observes seaborne exports are up 16.5% year on year and guidance is being revised ever higher by major producers. 2014 could well be the second consecutive year where export growth is more than 1bn tonnes. Australia's share of global seaborne supply will rise to 52% from 42% in 2011. While much of the ramping up of production has passed the analysts see the potential for additional productivity gains in iron ore, plus the usual seasonal uplift into the second half, to result in further sequential growth. The impact of this increased supply could have been even more pronounced had not previously dormant areas of demand seen a recovery. So far high cost Chinese domestic producers have borne the brunt of the pressure but in the second half of this year the higher cost seaborne supply will be under increased competition pressure to push material into China. To Macquarie, this adds up to a lower iron ore price.
Macquarie does not think iron ore financing deals are of a scale that would cause disruption. Any impact of credit tightening is of some concern, with the potential to inhibit mill and trader ability and/or willingness to buy iron ore from the seaborne market. BA-Merrill Lynch analysts also think the negative sentiment around inventory used in financing deals is overdone. Overall inventory levels are not particularly high, in their view, and imports year to date are more than accounted for by underlying consumption. They believe the increase in seaborne supply from Australia in the current quarter is the bigger factor pressuring prices. Still, they also think the biggest increases in iron ore supply this year are now behind the market, and prices should range between US$100/t and US$120/t. Merrills believes a re-setting of the multiples for iron ore stocks is likely, as investors become more comfortable with the underlying perspective on iron ore prices.
From the left of field, UBS has canvassed the potential for a subsiding of China's property sector to affect the steel raw materials trade. In summary, the broker's China economist contends that no resources equity offers protection against a short-term, broad hit on property. Assuming China's import-to-domestic iron ore ratio remains unchanged (70:30), and iron-in-scrap share is held at 110mt (14% of total iron units), then a 4% fall in steel production rate would result in a 4.6% fall in total raw material volumes. Specifically, total iron ore requirements would fall 56m to 1.15bn tonnes. The economist is concerned about the risk of a property downturn in China.
If the sector is subdued in 2014, a 15% probability exists for a sharp property downturn, prompting a broader fall in economic activity. There's no evidence of this occurring as yet but the risk is rising, with the economist citing potential triggers such a new property taxes, new non-property investment options, a lift in land/property supply and deterioration in property price expectations.
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