Goldman Sachs likes iron ore near-term but says prices will fall in 2018

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Iron ore is in a bull market, rising more than 20% from its mid-June level to sit just above $70 a tonne.

Here’s the daily chart of the benchmark price for 62% fines over the past year.

Quite a recovery, recouping around half of the losses that occurred between February to June this year.

And, according to Goldman Sachs’ commodity research team, there’s likely to be further strength to come for the red stuff, at least in the short-term.

Here’s a snippet from a research report released by the bank this week:

In our view, the strength in iron ore prices is likely to continue in the short term, as strong Chinese steel and iron ore demand from infrastructure and property new starts is complemented by solid growth in global activity ex-China. Moreover, ongoing supply-side restrictions in China, together with potential new supply issues such as winter supply cuts, are likely to continue to support Chinese steel margins in the near term.

Given that steel output remains constrained in China, Chinese steel exports are likely to continue to decline as the extremely strong domestic margins attract material to be sold on the mainland, driving ex-China margins up and resulting in ex-China steel mills raising steel output (and thus iron ore demand) to balance the global market.

While Chinese steel output is likely to remain constrained, we expect it to outperform its ‘seasonal’ pattern of declining sharply during the 2H. This Chinese outperformance, combined with upward pressure on ex-China margins, is likely to absorb the iron ore supply growth scheduled for the next 3 months. We find that the sharp Chinese steel production declines during the 2H of the years 2011-2015 largely reflected demand weakness, as steel output rose through the 2H of 2001-2007 and 2009, and was flat through 2H16. This key near-term bear argument is, in our view, a weak one.

So a combination of strong steel and iron ore demand from both China and abroad, along with steel production cuts in China due to environmental considerations during winter, will support steel margins and iron ore prices in the near-term in Goldman’s opinion.

And, as opposed to some other analysts, the bank is not overly concerned by bulging iron ore port inventories in China.

It explains:

We believe the current high level of Chinese iron ore port stocks — another key bear argument — is not as bearish as it appears, since total steel mill and trader steel and iron ore inventory in Fe content is at a relatively normal level in terms of days of consumption.

Goldman says that, in its opinion, high iron ore inventory levels are offset by low steel stocks, noting that the latter has been affected by supply-side reforms to eliminate steel production from outdated and uneconomic mills.

Here’s how Chinese iron ore and steel inventory levels currently sit compared to recent years.

Source: Goldman Sachs

Given that assessment, Goldman has decided to upgrade its forecast for iron ore over the next three months, lifting it to $70 a tonne from $55 seen previously.

However, longer-term, it’s a little more pessimistic on the price outlook, mirroring sentiment from the vast majority of forecasters.

We take a bearish view during 2018, as we forecast in our base case a slowing in global steel demand and output (iron ore demand) growth, and strong supply growth in iron ore.

Our expectation of a gradual slowdown in steel demand partly reflects base effects, but is also driven by our expectation that China will slow credit growth and this will have a disproportionate impact on the steel-intensive old economy sectors.

On the supply side, we expect supply pressure to build into 2018 — mainly driven by Vale, Rio Tinto and BHP — and the market would need lower prices to clear a seaborne surplus of more than around 100 million tonnes during 2018, which we estimate at around $50-55/t based on the cost curve.

Goldman expects prices to fall to $55 in the first half of 2018 before extending those declines to $50 by the end of next year.

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