Bulk Commodities: Dead Cat Bounce?

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– Iron ore storm is over
– Steel demand remains weak
– Little price upside potential
– Coal also impacted

By Greg Peel

Iron ore producers can breathe a sigh of relief, ANZ’s commodity analysts suggest, as it appears the perfect storm in market conditions has now passed. A one month rally in the spot price of 30% has brought an end to the 65% price plunge over the previous fourteen months. A floor of US$47/t was reached when the likes of BHP Billiton ((BHP)) and Brazil’s Vale announced intended production curtailments.

That is not to say prices will now dutifully return to pre-plunge levels. ANZ believes the fundamentals still look weak. Low cost production continues to grow and enter the market, and lower raw material prices have only had only a modest positive impact on steel prices. The analysts have downgraded previous price forecasts, suggesting iron ore will remain in a range of US$50-60/t over the next twelve months.

A US$50-60/t price is not sufficient to sustain high cost producers, ANZ notes. In the December quarter last year, 45mt of seaborne ore supply was shut down in Canada, Sweden and Sierra Leone while in the March quarter, Chinese production fell 8% year on year, equivalent to another 30mt of reduction.

On the positive side, production cuts from the major, low-cost producers, Beijing’s liquidity injection in the form of a big cut to the bank reserve ratio requirement (RRR) and seasonal improvement in demand from Chinese steel mills have helped fuel the price rebound. But on the negative side, a tempered recovery in China’s house price cycle will drag on steel consumption. Slowing property construction, which accounts for 40% of Chinese steel consumption, will not be sufficiently offset by increased government infrastructure spending.

ANZ forecasts Chinese steel consumption to fall 4% in 2015 and another 2% in 2016.

The other imput to steel production is coking coal. The plunging iron ore price rather took the spotlight away from coal prices, which have also been steadily falling. The impact on coal producers has not been so dramatic nonetheless, given coal production costs have also been falling and big savings being made by steel producers on the iron ore side have resulted in less pressure on coal prices.

However, lower demand will continue to weigh on coal prices, ANZ suggests. Lower costs for the industry mean latent coal supply can be swung into action at any time, thus keeping a lid on any iron ore-style price bounce.

Thermal coal, used for power generation, is suffering from an even larger supply overhang than coking coal, ANZ notes, but this does seem to be priced in. Inventories of thermal coal at Chinese ports are sitting at an unseasonably high 32mt heading into the summer and are unlikely to be drawn down as seasonal demand slows, ensuring ongoing pressure on prices.

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