(The opinions expressed here are those of the author, a
columnist for Reuters.)
By Andy Home
LONDON May 16 "We expect that the price in the
second half will be better than the first half. One thing is for
sure, the price will not go below $110 on a sustainable basis. I
think we have many times seen the price going below this level,
but recovering very fast."
So said José Carlos Martins, executive officer of ferrous
and strategy at Vale, the world's largest producer of
iron ore, speaking on the Brazilian company's Q1 analysts call.
The spot price of 62 percent iron ore, as assessed by the
Steel Index .IO62-CNI=SI, stood at $102.80 per tonne on
That doesn't make Martins wrong.
Since 2009 the iron ore price has slumped through that level
on only a couple of occasions, most dramatically in the third
quarter of 2012 and again in March this year. On each occasion
the market was in panic de-stocking mode and, sure enough, the
price quickly recovered.
That March rebound has faded quickly, however, and here we
are below the "magic" number again.
So should we expect another quick bounce, as Vale and its
producer peers argue?
Or is this market collectively ignoring the elephant in the
room that is the weakness of the single most-important driver of
THE "MAGIC" NUMBER
The existence of a magic number below which the price of
iron ore cannot sustainably stay is widely accepted, although
there are as many magic numbers as there are analysts.
But most think that it's there somewhere in the $100-120 per
Iron ore is by no means unique in this regard. Indeed, the
concept of a floor price is common to every commodity market
suffering from oversupply or heading towards oversupply.
Iron ore is in the latter category. Until this year the
world's producers simply weren't digging enough of the stuff out
of the ground to meet demand from China's huge steel sector. The
result was a tripling in the price from the start of 2009
through to the middle of 2010 and a subsequent period of
sustained high prices due to continued supply shortfall.
Now, however, Australian producers in particular are
cranking up production to the point that 2014 is widely expected
to be a year of significant oversupply.
In an oversupplied market, the price should in theory come
down to a level at which higher-cost producers exit, forcing a
rebalance with demand. In the case of iron ore this primarily
means squeezing out smaller Chinese producers.
There are lots of potential variables that can affect the
rebalancing process, from the speed at which new supply comes on
stream to the natural reluctance of those that should close to
actually make the decision to do so.
In short, the price can and often does stay below the magic
number for longer than many expect before supply-demand
equilibrium is re-established.
But that doesn't negate the validity of the idea that
production costs will over time define the downside of any
STEADY AS SHE GOES?
Of course the size of that surplus holds the key to how much
higher-cost production must be forced out and at what price.
Hence the current focus on how the big expansions in
Australia's Pilbara are faring. Very well, in the case of the
big three producers, Rio Tinto, BHP Billiton and
Fortescue Metals, which has caused some analysts to
adjust their time-lines.
Forgotten, though, in this current fixation on the supply
side is what is happening on the demand side of the iron ore
Even with multiple signs of recovery in steel demand in the
rest of the world, it is China that holds the key. How could it
not, given the country accounts for almost half global steel
production and a still higher proportion of demand for seaborne
And superficially things look OK, or as OK as they could be
given the bigger story of Chinese growth slowing as Beijing
presses on with its policy of re-engineering growth away from
fixed asset investment towards a more consumerist model.
China's steel sector is moving up through the gears.
National output hit record run-rates in April
and that momentum continued into the first part of May
. Inventory levels are falling across the steel
All of which chimes with the "usual" strength of the Chinese
steel sector at this time of year, characterised as it is by a
resurge in construction activity after the Northern Hemisphere
Chinese steel demand growth may be slowing but it is still
growing and that's everyone's base-case scenario when it comes
to assessing the size of likely surplus in the seaborne iron ore
market this year.
There's just one small warning light flashing.
China's exports of steel products hit 7.54 million tonnes in
April, the highest level since August 2008, a telling reference
point since that was the time the global financial crisis was
fast morphing into global manufacturing crisis.
It's the third time this year that exports have soared past
the 6.0-million tonne mark. The cumulative year-to-date total of
25.87 million tonnes is up almost 30 percent from last year's
As analysts at UBS bank point out, April's net exports of
steel products were equivalent to an annualised 75.92 million
tonnes, or one year's worth of Japan's crude steel domestic
demand. ("UBS Global Signals", May 9, 2014).
That so much material is seeping out of China at what should
be a seasonal high point for its own demand is telling.
And it's not hard to figure out what the problem is. Just
about every signal coming out of the country is pointing to
trouble in the construction sector.
Prices are down, sales are down and new construction is
As analysts at Macquarie note, "the state of the real estate
market in China is possibly the most discussed variable amongst
those trying to gauge the demand outlook for commodities".
The bank's research note of May 13 is titled "China's real
estate market: riding out another cycle", which sums up
Macquarie's view that the current weakness in the sector is
cyclical not structural.
Not everyone would agree. Analysts at CHR Metals have been
warning for some time about China's property "bubble", noting
that official figures may be understating the scale of price
falls outside of major cities. ("Global IP Watch", April 2014).
"There are numerous reports of developers unable to repay
loans and this has consequences for construction companies,
construction material producers and equipment makers all of whom
are likely to be owed money," they said.
And, of course, the steel supply chain within China,
dominated as it is by traders.
Remember that the March mini-rout in iron ore was triggered
by stresses running along the multiple credit fault-lines
linking iron, steel and construction sectors.
China's construction sector is the single biggest driver of
global steel demand and therefore of iron ore demand.
It is the elephant in the room in a market which is now
obsessing about supply. If unleashed, it could trample all over
everyone's magic support numbers.
If that sounds like scare-mongering, consider another little
flashing warning sign.
Today the price of Shanghai rebar, the steel
product most used in construction activity, touched its lowest
point since the contract was launched in March 2009.
Hear that sound? Is it just me, or does that sound like an
(Editing by Pravin Char)