Iron ore has been crushed over the past four months, tumbling over 40% from the highs struck in late February.
It’s got many wondering when the rout will finally come to an end.
While no one know for sure in the ultra-short term, with daily spot prices gyrating wildly on a day to day basis, Deutsche Bank’s bulk commodities team thinks there is still more downside to come both later this year and in early 2017, forecasting that the benchmark rate for 62% fines will eventually trade below $US50 a tonne.
Here’s the reasoning behind Deutsche’s call.
There are three reasons for our cautious view on iron ore over the next six to twelve months. Firstly, credit conditions in China have tightened over the past quarter and although we think the worst is over the full effect is yet to be felt in terms of metal demand. We would point out that Chinese apparent demand of +10% is an illusion with illegal capacity never being tallied in the historical production numbers. Secondly, scrap that was being utilised by the illegal induction furnaces has travelled and is displacing iron ore units. The increase in scrap utilisation is being mirrored elsewhere in the world. Thirdly, supply from all quarters is responding to the period of higher prices and shipments have been increasing post a seasonally weak Q1. We estimate the marginal cost of the seaborne market is around $US55/t, but due an ensuing destocking cycle, prices need to fall below this level to clear the market.
Reflecting those factors, Deutsche sees the benchmark price averaging $US50 tonne in the December quarter this year, a level that is expects it to consistently trade below in early 2018.
However, differing this forecast from some others, it doesn’t see prices remaining at these levels forever, suggesting it’s unlikely to last beyond a couple of quarters.
While $US50 a tonne or slightly below will hardly worry the big iron ore miners such as Rio Tinto, BHP, Vale or Fortescue, it will hurt miners higher up the cost curve. And with Chinese steel demand unlikely to collapse in Deutsche’s view, the bank says it may help to further address supply-demand imbalances within the iron ore market.
Here’s the assessment:
Although it is difficult to paint an outright bullish picture for Chinese steel demand, we do not see an outright collapse. Even if order books for the state owned constructors decline in 2018, the lag between order book and project spend should ensure that Chinese steel demand remains reasonably firm. Furthermore, the profitability of the Chinese steel industry post the closure of illegal capacity means that raw material affordability is better. Our blast furnace cost model does however point to the high discount for low grade ore being partly structural. Lastly, there is some cost curve support. Large portions of the Indian and Chinese iron ore industry is unprofitable below $60/t, let alone $US50/t, and we estimate that at $US45/t, at least 200 million tonnes of the 1,500 million iron ore market is loss making. This is unsustainable for any extended period in our view.
On the latter point — the break-even point for iron ore producers — this chart from Deutsche shows the advantage the big Australian and Brazilian iron ore miners enjoy compared to producers from India and China who sit further up the cost-curve.
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