Iron ore boom or bust

TW COMMENT: it has been a week of mostly positive news flow for iron ore (Japanese demand, a 2011 supply shortfall, firm prices and a forecast 12% rise in China’s steel production this year). Plus, we have seen the spectacular debut on public markets of commodities trader Glencore (market cap. $59 billion). It is thus interesting that Baosteel’s Chairman has chosen now to make bearish comments on the future performance of the iron ore sector; and there could well be a ‘political’ element at work here? Similarly, Macquarie’s forecasts for what might happen to prices in 2014 (i.e. broadly halving) are just that - forecasts; particularly as it is also predicting a 36% rise in seaborne irOn ore volumes by 2016.

BAOSTEEL CHAIRMAN IS CAUTIOUS
The iron ore market has risen to “bubble” levels which will burst as new mines create oversupply of the steelmaking raw material, according to China’s second largest steek maker Baosteel Group. “There is a bubble in this market, many are gambling”, making acquisitions and investment expensive said Chairman Xu Lejiang in an interview in Shanghai, without saying when prices would drop. “Everyone who has money is rushing in to invest in iron ore”.

Vale, Rio Tinto and BHP Billiton, the three biggest suppliers, plan to spend $45 billion on mines. “The reason the big three keep spending is that they probably think growth in India, Brazil, Russia and South Africa will be sustained, and also because they believe the return on their input would beat those blind investments” by smaller rivals, continued Xu. The biggest losers from the new mines may be the speculative companies which have not yet started production and their investors, he added. “Some investors are simply making money by trading the iron ore projects before seeing actual output. Iron ore prices will definitely fall at some point because the supply demand situation will have a turnaround”.

Demand from steelmakers in China has spurred an almost threefold jump in the cash price for 62% iron ore delivered to Tianjin since 21 November 2008 (when data became available) according to the Steel Index. It was $175.30 per ton on 19 May. Producers valuations have also soared and the Bloomberg Global Iron Ore Mining Index of 30 iron ore companies have surged four fold since 2008. “In Australia, South Africa and America, I’ve seen a lot of investors whom only ‘dig’ iron ore on the stock market, they will never see physical output” from their mines, said Xu. The average profit margin of Chinese steelmakers was 3.5% in the 2010, the lowest of any industry, because of overcapacity and rising raw material costs, according to the Chinese Government. This is about a tenth of the margins the largest iron ore miners make, added Xu.

Macquarie Group (18 May) says iron ore may trade between $150 and $190 a ton for the next three years before declining to a long-term average of $80 a ton after 2014 as demand growth in China slows. However, global seaborne supply may increase to 1.48 billion tons by 2016, from a forecast 1.09 billion tons this year.

BHP will spend $6.6 billion expanding output in Western Australia to more than 220 million metric tons a year. Meantime Rio Tinto is spending $14.8 billion to boost output by 50% to 333 million metric tons and Vale plans to invest $24 billion this year alone on expansions.

Iron ore supply may outstrip demand “sooner than expected,” as production increases after record prices spurred investment in mines, in Xu’s view (earlier he had orecast the market to move into surplus in 2014).

China has been encouraging State-owned steelmakers to invest in overseas resources to cut their dependence on the three miners. Baosteel is “very interested” in participating in Rio Tinto and Aluminium Corporation of China’s Simandou iron ore project in Guinea, said Xu. Similarly, Wuhan Iron & Steel has invested in eight projects in Canada, Brazil, Australia, Liberia and Madagascar.