Metal Matters: Iron Ore, Steel, Alumina and Lead

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-Iron ore to ease, a little
-Chinese steel production modestly firmer
-Alumina should soften then rebound
-Lead a buying opportunity
 

By Eva Brocklehurst

The iron ore price will ease, not collapse. This is the opinion of Morgan Stanley. The spot price likely peaked at US$159/t and should edge down over the remainder of the year. The broker is not the only one that believes the price will fall, but is more modest about how far. Morgan Stanley's forecast for 2013 is an average price of US$133/t, implying an average of US$129/t over the remainder of the year. Prices bounced late last year principally because of re-stocking in steel and associated raw materials, and unusually tight spot markets. Sentiment regarding a rebound in Chinese steel was also very bullish.

These three factors have not abated entirely, Morgan Stanley contends. Chinese steel production should grow 2.6% this year to 729m tonnes. Translating this to the price the market is paying for Australian exports of iron ore leads the broker to believe they are undervalued. Ergo, estimating the iron ore price implied by the current share price of the three pure iron ore plays, puts the price at US$107/t for Fortescue ((FMG)), US$110/t for Atlas Iron ((AGO)) and US$107/t for Gindalbie Metals ((GBG)). Morgan Stanley believes the market over-reacted to the announcements from the Chinese government regarding tighter real estate controls. Iron ore and Chinese steel prices have fallen since the third week in February but the broker does not expect much, if any, impact on actual steel production. Although not forecasting a rebound of 2009's magnitude, the broker expects reasonable strength in property and land sales this year.

Macquarie also finds it hard to be too bearish on either iron ore or steel. The broker's survey of mills, steel and iron ore traders shows expectations for March, while positive, are modest compared with the same time last year. The amount of de-stocking that took place signals to Macquarie that, for iron ore at least, there is more replacing to be done. That said, preliminary port data suggests differing export volumes for major iron ore producers thus far in 2013. Over the first nine weeks of the year, Brazilian exports were flat and Rio Tinto's ((RIO)) exports dropped 7.2%, largely because of the disruptions from cyclones. BHP's ((BHP)) shipments rose 3% year-on-year over the same period and Fortescue's exports were up 62.1%. Meanwhile, shipments from smaller Australian producers rose 17.8%. Macquarie expects Australia to supply the vast majority of iron ore supply growth this year.

As for Chinese steel mills, the broker notes the larger mills have been re-stocking iron ore as conditions have improved. They are now intending to reduce purchases. The question posed is: can smaller mill re-stocking offset this? In Macquarie's view it can. When this happens, Chinese consumption of iron ore will increase. Steel inventory levels look high but according to the broker that is a normal development over Chinese New Year. The risk in the scenario is that, as data from the survey suggests, the build up in inventory has been mostly in long products. Given that smaller mills are typically long product producers and were cutting production, the fact that inventory has risen so quickly suggests that construction activity must have been very poor over January and February. In the broker's view the build up in steel inventory could prove problematic, particularly if construction activity does not pick up strongly.

UBS has swallowed pride, noting forecasts that alumina prices would be depressed by increased bauxite flows into China have not been realised, at least so far in 2013. The broker claims the lift in Chinese bauxite imports to normal levels has occurred as predicted, but the alumina price has also risen. Several factors contributing to the strength in alumina prices include the abating of the risk that Rio Tinto would shut the Gove refinery. This fear pushed up prices in January. Rio Tinto subsequently announced the refinery would remain open, having negotiated a gas supply deal with the Northern Territory government. Weather in Queensland also disrupted bauxite exports from Weipa and production at Yarwun refinery was also temporarily suspended, pushing up prices. 

Also, China has been diversifying its supply of bauxite imports, with an increase in that coming from India and Guinea. These locations carry higher freight costs and this provided a cost-push benefit to alumina as an alternative import. China traditionally sources 80% of bauxite needs from Indonesia but is diversifying as Indonesia plans export bans on bauxite in 2014, with the imposition of taxes on exports as a move to capture some of the value of upgrading within the country. UBS believes the disrupted bauxite trade also had a delayed impact on Chinese domestic alumina production because of stockpiling. Upgrading bauxite in China allows the domestic aluminium industry to capture more of the upstream value. 

As Chinese alumina refineries re-stock bauxite the broker expects a lagged lift in production, undermining the alumina import trade which rose to 5m tonnes in 2012. This should provide a headwind to spot alumina prices and UBS expects these to decline to US$320/t free on board in the June quarter. The broker is bullish on alumina from 2014, when the Indonesian bauxite export bans are due to be enforced, expecting alumina prices will then strengthen on the basis that alternative sources of bauxite carry higher freight costs, substitution to alumina from bauxite as aluminium feed and the lack of investment in western alumina capacity.

Deutsche Bank expects lead could be better supported by its relatively tight fundamentals as compared to its base metal peers, many of which are expected to be in surplus this year. The broker forecasts a modest deficit for lead in 2013 and expects this could increase moderately in the coming years. Mine production is expected to grow at 3% this year, lagging expected smelter expansions. Lead mine production is expected to average just 3% out to 2020, down from double digit growth in 2010-12, as ore reserves are depleted and mines are closed.

The broker notes secondary lead production, which accounts for a significant portion of refined supply, may come under more pressure as environmental regulations in China tighten. Such is the implication from China's pollution crisis, but it's not necessarily one-sided. A raising of standards could lead to faster scrapping of old vehicles and that could increase new car sales. The long term impact is also limited as modestly lower sales could be offset by higher exports. Furthermore, growing demand for industrial batteries from the telecom and the clean energy sectors may provide support to lead. Deutsche Bank believes that the current retracement in lead prices is creating a buying opportunity and fair value is around US$2,300/t at this stage of the business cycle.
 

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