Why the iron ore rally may not have legs of steel
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Life just got complicated for those who had rested their case for a prolonged bear market in iron ore. Falling iron ore prices have reversed swiftly and Monday’s 19% increase surprised everyone. Even if this is a blip, it is no ordinary one as iron ore prices have gained 46% so far this year. Fundamentals have not changed though. Here are five reasons why the case for a sustained increase in iron ore prices does not seem convincing yet:
1. Globally, commodity prices are enjoying a reprieve from a punishing decline, with crude oil leading from the front. There are no visible reasons underpinning this recovery, making some wonder if this will continue. If global commodities resume their decline, then iron ore is likely to follow suit.
2. One prime reason why iron ore prices had been falling is an increase in mined output at a time when the global outlook for steel was weak. There is no change in the situation. Large miners have deferred future capex plans but are looking to finish building factories where money is already sunk. All said, rising iron ore output remains a threat.
3. China’s weak economic outlook was another reason for depressed iron ore prices. Recently declared economic growth targets for 2016 and the next five years, and indications that the Chinese government will support growth, appear to have been taken at face value. Tuesday provided a reality check: China’s exports in February fell by 25.4%.
4. As of January, steel output trends based on the World Steel Association’s data do not indicate a trend reversal, especially in China. Here’s a twist. A Reuters report dated 7 March says steel mills in Tangshan, China may have to limit output between 29 April and 16 October, to lower air pollution to facilitate a horticultural event. Tangshan is a top steel producing region. The fear is that steel plants may produce more now to stock up for the period when production will be slack. This in turn may lead to higher demand for iron ore and, therefore, higher prices now, but won’t be enough to support prices for more than a few months.
5. Global steel demand continues to be weak. China’s steel exports have been flooding global markets prompting countries to take anti-dumping measures. Two factors can reverse this flood; China’s domestic steel demand recovers or it limits steel output through permanent measures such as shutting down plants. A demand recovery in other major economies too could be a trigger. Till that happens, it is difficult to accept that this iron ore rally has legs made of steel.
For the moment, higher iron ore prices and the resultant likely increase in steel prices bode well both for miners and steel companies. Enjoy while this party lasts.