Strong Iron Ore Market To Continue

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-Iron ore prices hold up
-Merrills raises forecasts
-Chinese steel growth solid
 

By Eva Brocklehurst

China's crude steel output has begun to ease through October, as is usually the case, consistent with the coming of winter and the usual ebbing of steel production as demand slows while construction projects in the north wind down. Up to now, iron ore demand in China has been stronger than expected and BA-Merrill Lynch notes there's be only mild softening of prices towards the end of the year, as supply peaks in November and December.

Commonwealth Bank analysts have also observed that Chinese mills have come back into the iron ore spot market to re-stock in recent weeks, as the usual de-stocking around the National Day holidays was only mild. The main re-stocking ahead of winter is usually undertaken later this month. Merrills expects the March quarter re-stocking will support prices.

Merrills' average iron ore price forecasts have been raised by around 10% to US$120 per tonne and US$110/t for 2014 and 2015 respectively. Higher Chinese steel production numbers are incorporated into these estimates. There's a significant amount of new capacity coming on stream in the course of 2014 (around 180mt) and Merrills thinks that the combination of capacity closures in the fourth quartile of the cost curve and continued healthy Chinese demand should help balance the market. The rebound in prices in the first quarter will be characterised by seasonally lower iron ore supply from China, Australia and Brazil and re-stocking at steel mills in China. Historically, the first quarter of the year has been the strongest quarter for iron ore prices, with averages above US$140/t in the last three years. Merrills forecasts March quarter 2014 prices at US$135/t.

The risks to the more positive call are Indian iron ore exports that end up above the forecast 20mt. Should port inventories (10-13mt) be released, or the Goa mining ban cancelled, exports could actually exceed 30mt. The other risk is weaker Chinese steel production. Merrills expects steel production to grow 5.8% in 2014. The demand base from 2013 is likely to be higher. Chinese steel production is currently up 9% versus Merrills' 5% growth forecast made at the beginning of the year.

Commonwealth Bank analysts note Chinese iron ore imports were near record highs in September. The analysts expect further government stimulus for infrastructure and affordable housing supply could support sentiment and pricing. Property sales momentum is providing visibility on the real estate construction outlook for 2014 and the market is looking robust. The analysts do not expect the iron ore price to go below US$100/t. Over the next two years support is seen above US$110-120/t because 180-220mt of expensive Chinese supply will exit the market when prices test the downside limits. Merrills, too, observes that the trailing 3-month average iron ore price has never broken US$100/t and this indicates strong cost support. Iron ore prices may remain volatile, driven by de-stocking and re-stocking and new supply, but a collapse is not expected, sustained by the high cost of production in China.

The CBA analysts expect new construction starts will remain strong in both level and growth terms well into 2014. This will support higher steel demand growth next year, consistent with the the analysts' forecasts for 5% growth. Steel capacity in China is seen as in chronic oversupply. Despite easing in steel prices, margins are actually slightly improved since the higher prices of 2011 and the analysts take this to mean iron ore prices can be sustained in the near term.

Merrills estimates an additional 18mt of iron ore volume will hit the market in 2014, with projects for the big four miners ramping up. The question is when supply increases will hit the market and have the largest impact. The analysts suspect it should be in the second quarter of 2014, with some easing in the fourth quarter. Merrills has also raised steel production estimates for 2013-15 to reflect higher Chinese growth in 2013-14. Beyond 2015, steel production grow rates are expected to slow as China begins to shift to more consumer-driven growth.

Having re-cast the iron ore price forecasts, among Australian stocks, Merrills finds Fortescue Metals ((FMG)), Rio Tinto ((RIO)) and junior miner Atlas Iron ((AGO)) stand out. Irrespective of whether the price follows the analysts' model the broker considers the strong price momentum sends a message to the miners to "make hay while the sun shines".
 

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