Why nothing is stopping the crushing slide in iron ore

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Iron ore prices are falling hard again this week.

This is a gathering storm for Australia. Chris Richardson of Deloitte Access Economics estimates that price slide could strip a further $3 billion in revenue from the federal budget.

And then there are the potential impacts on small and medium-sized iron ore producers who have production costs in the region of $US50 a tonne, the threshold that seems to have been breached on the market overnight.

(One of these projects is Gina Rinehart’s $US10 billion Roy Hill mine in WA. It’s still under construction but UBS reportedly has pegged the breakeven iron ore price at between $US50 and $US57 a tonne.)

The relentless fall has stumped some observers, especially as China has announced some environment and property policy adjustments that should stimulate demand for iron ore. In a note out this morning Morgan Stanley’s commodities team has tried to shed some light on what’s going on in the market and why nothing seems to stop the slide.

In summary, stimulus measures are actually being seen as “bad news”, and there’s a compounding effect from other market forces. Here’s Morgan Stanley:

The expectation of lower steel production in China based on environmental considerations, though not new, did get extra momentum from the lower GDP data. In this environment the on-shore traders of iron ore in China have become more circumspect and less inclined to bid for cargoes. In the minds of these China-based traders, it seems ‘bad news’ is ‘bad news’ and the potential for stimulus does not invigorate them. Policies designed to energize the key steel end-use markets (property, infrastructure) will take many months to translate into real, physical demand.

Whatever glimmer of hope you can see in that analysis is just that: hope. And then there are the other forces at work: high supply, and other downward cost pressures including fuel and currency.

The iron ore physical market has not seen any stockpile accumulation since the conclusion of Chinese New Year. Also, there are a few unsold cargoes at sea heading for China. This places the spot market price influence in the hands of the buyers. The participants that actively trade in the market are preparing for lower production costs for iron ore (from inputs such as fuel and FX) to contribute to lower prices in the marketplace.

Overall, Australia is at the lower end of the global cost curve – only Brazil is cheaper among the major producers. But that’s in aggregate: the profit margins for different mining operations across the industry vary wildly. Yesterday BC Iron, one of the smaller miners, announced it would be deferring payment of millions of dollars in mining royalties to the WA Government until next year. This may be just the start of some problems in the sector that drove Australia’s boom.

Of course the market may be close to bottoming out and stabilising. But with the minds of traders in the market as gloomy as they are, you wouldn’t want to be holding your breath waiting.

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