COLUMN-China's iron ore, steel prices diverge as trade war vies with supply woes: Russell

(The opinions expressed here are those of the author, a columnist for Reuters.)

LAUNCESTON, Australia, June 18 (Reuters) - China’s iron ore and steel prices have decoupled somewhat in recent weeks, with the raw material still making fresh highs while the finished product trends lower.

While there are solid supply-driven reasons for iron ore’s relative outperformance, the question remains: how is the current divergence likely to be resolved?

Iron ore futures on the Dalian Commodity Exchange closed at 769.5 yuan ($111.20) a tonne on Monday, down slightly from their record close of 787.5 yuan on June 14.

However, benchmark steel rebar contracts in Shanghai ended at 3,716 yuan a tonne on Monday, down 4.8% from their 8-1/2-year peak of 3,905 yuan on May 22.

In year-to-date terms, iron ore futures are up 75%, while steel rebar has gained a more modest 19.4%.

The outperformance of iron ore can be explained by the sudden loss of millions of tonnes from No.2 exporter Brazil in the wake of mine closures for safety checks after a tailings dam burst in January that left more than 200 people dead and numerous still unaccounted for.

The supply situation was exacerbated by a tropical cyclone that struck in late March in northwestern Australia, the main iron ore producing region in the world’s top exporter of the steelmaking ingredient.

China, which buys about two-thirds of seaborne iron ore, has seen imports slip this year, with customs data showing a drop of 5.2 percent to 424 million tonnes in the first five months of 2019 from the same period a year earlier.

A further sign of tightness in the iron ore market is the slump in inventories at Chinese ports SH-TOT-IRONINV, which dropped to 118.7 million tonnes in the week to June 14, the lowest level since the start of 2017 and about 43 million tonnes below the peak reached in June last year.


Turning to steel and in some ways it’s impressive that the metal has gained at all this year, given the headwinds it’s facing from the ongoing trade dispute between China and the United States.

While the authorities in Beijing have acted to boost construction and infrastructure spending, the major consumers of steel, other sectors such as manufacturing and vehicle assembly have seen declines.

The Purchasing Managers’ Index for manufacturing has been below the 50-level demarcating expansion from contraction for three of the first five months in 2019, with May’s reading of 49.4 coming after two months of holding above 50.

Given the supply crunch facing iron ore and the demand clouds hanging over steel, it’s not surprising that the prices of the two have diverged recently.

Assuming they will eventually return to the generally strong correlation they have experienced in the past, the question is then whether it’s likely that iron ore will moderate or steel will rally?

This will largely depend on the path of the trade dispute and the success of China in stimulating its economy.

If Beijing does manage to once again prop up activity through spending, then steel is likely to gain.

However, any signs that this isn’t happening will eventually weigh on iron ore as Chinese steel mills, which have already seen previously robust margins shrink this year, are likely to pull back on output.

Already it would appear that mills are starting to prefer lower grade iron ore, which reduces their costs but also produces less steel per tonne of ore used.

Iron ore with 58% content for delivery to China MT-IO-QIN58=ARG, as assessed by commodity price reporting agency Argus, has narrowed the gap on higher grade 62% ore.

At the end of last year 62% ore commanded a 14.6% premium over the 58% grade, but by Monday that had shrunk to just 7.2%.

If iron ore continues to rally, or even remain at elevated prices, it’s likely more Chinese mills will be tempted to switch to lower grade ore, especially since most of this comes from Australia and hasn’t been affected by the Brazilian outages.

Editing by Joseph Radford