23-04-2016

Iron ore nears $US70 but analysts warn rally won’t last

iron

Iron ore miners have been breathing a sigh of relief over recent weeks, with a spot price rebound taking the pressure off the embattled sector.

The iron ore spot price at the Chinese port of Qingdao has almost doubled from a December low of $US38.30 a tonne to more than $US70 a tonne overnight.

Yesterday alone, the benchmark spot prices in China jumped more than 7 per cent.

The rally has raised the profit outlook for the big miners, who are once again enjoying very healthy profit margins on the ore they dig up and ship out at current spot prices.

BHP Billiton shares punched back through the $20 level this week for the first time since November, with Rio Tinto now comfortably above $50 rather than below $40, and Fortescue sitting around $3.50 up from January lows more than $2 below that.

For smaller miners, the price rise into the $US60 range is a potential lifeline, returning them to profitability and staving off the administrators (although it was notably too late for Arrium, but may still aid that company’s survival).

Iron ore rally could be blown up by ‘credit time bomb’

While the reprieve is welcome, most analysts in the sector also believe it is temporary.

“For now commodity exposed miners are breathing a little easier. But for price upside to be sustained, better underlying demand is needed,” wrote UBS commodity analysts in a recent note.

“There have been green shoots in China’s property market, infrastructure activity has lifted & policy makers have signalled a more pro-growth stance. But we are yet to be persuaded and await further evidence before adopting a more positive stance.”

Resources analyst Tim Treadgold said the surge is due to strong demand from China which is trying to stimulate its economy.

However, he warned that the stimulus is debt-funded, which may lead to bigger problems down the road.

“They’re encouraging building, they’re encouraging investment,” he explained.

“The real worry is whether they’re doing what the United States did and they’re encouraging this sort of growth through the build up of credit which is setting a credit time bomb in the Chinese economy which we will have to be very conscious of.”

Tis’ the season for iron ore

Even putting the serious risk of a future Chinese debt crises aside, analysts warn that the current iron ore prices might be as good as things get this year.

That is because the iron ore market is highly seasonal on both the demand and supply side.

Supply wise, Australian and Brazil are both in the southern hemisphere with their iron ore mining regions exposed to monsoon rains and tropical storms that often disrupt production over summer.

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Iron ore demand is highest and supply lowest during March to May. / UBS

On the demand side, the disruption of northern China’s often harsh winter is passing in the northern spring, as is the disruption of the Lunar New Year holiday. Steel mills are clearly ramping up their stocks in anticipation of the summer building boom.

UBS warned that this makes the iron ore rally vulnerable should the stimulus-fuelled building boom come to a halt.

“These prices are discounting better underlying steel demand to emerge from additional Chinese property and infrastructure stimulus,” the analysts cautioned.

“Should this not come through as anticipated, iron ore prices will weaken in tandem with steel prices as seasonal activity slows from around mid-second quarter 2016 and into the third quarter of 2016.”

Worsening iron ore glut a ‘key downside risk’

Added to this, analysts at Morgan Stanley are still concerned about the amount of extra iron ore supply soon to hit the market.

“We see new supply (in particular Roy Hill and Vale) as a key downside risk to the iron ore price,” they wrote in a note.

“We see iron ore prices average $US39/dry metric tonne (dmt) and $US37/dmtt in 2016 and 2017 [respectively].”

An average price of under $US40 a tonne for this calendar year would require lows in the low-$US30s or even high $US20s during the seasonal downturn in the second half.

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Iron ore prices are now well above the cost of production for most miners. / Morgan Stanley

UBS is not that pessimistic.

“We feel supply will respond in a rational manner that preserves value of volume at marginal pricing of $US45/tonne CFR China in 2016 and $US46/t in 2017,” they forecast.

Today’s action on the share market shows that these forecasters are not alone in being more than a little wary of the iron ore price surge in early 2016.

BHP Billiton, Rio Tinto and Fortescue were off between 3-6 per cent by late-afternoon trade.

“The equity market continues to take a cautious stance on the sustainability of these recent iron ore highs,” Morgan Stanley concluded.

Given the headwinds and risks outlined by the analyst community, that is potentially a wise stance to take.

Source: Abc.net

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