Across The Border
by

Iron ore prices to remain buoyant in early 2017 but could soften in second half, analysts say

PUBLISHED : Monday, 12 December, 2016, 4:00pm
UPDATED : Monday, 12 December, 2016, 10:23pm

Iron ore has become one of the hottest commodities of the year.

Its price has almost doubled over the past year, startling investors and analysts who had anticipated the commodity would suffer another dismal year after three annual declines due to significant oversupply.

China’s stricter rules to combat pollution, ongoing supply-side reforms to curb capacity, and “hot money” may have largely pumped up iron ore price , some experts said. They now expect the price strength could continue into 2017.

Iron ore pulled back Friday night after hitting US$82.4 per tonne on Wednesday – its highest level since September 2014. However, the commodity is still up almost 90 per cent this year, after plunging to a seven-year low in December 2015.

This defied earlier expectations of iron ore price weakness in the fourth quarter by a number of investment banks, including UBS, Morgan Stanley and Citigroup.

As a result, many analysts have recently revised their forecasts.

Goldman Sachs upgraded its forecast on iron ore prices to US$65, US$63, and US$55 per tonne in three months, six months and 12 months, respectively.

JP Morgan analysts also increased their 2017 iron ore price target to US$60 per tonne from the previous US$54.

They said the unexpected rally in iron ore price has been largely driven by hot money from Chinese speculators.

Rising Chinese demand is also a key factor as mainland steel mills increased the use of higher grade iron ore to reduce production cost after the price of steel-making ingredient metallurgical coal (met coal) surged.

“Significant price volatility [in iron ore] has occurred from short-term market drivers, such as speculative trading, the ability of higher steel prices to impact trader mentality and pull up iron ore prices, and the influence of other steel raw material prices such as met coal [acting as a cost push on steel prices],” JP Morgan commodity analysts Lyndon Fagan, Hugh Stackpool and Jonathan Koay wrote in a recent research report.

The underlying cause is China’s stricter anti-pollution rules and supply-side reforms designed to cut capacity in the coal and steel sectors, which caused supply disruptions and pushed up steel prices and met coal costs, analysts said.

China’s steel industry is a major cause of air, water and soil pollution. Hebei province, China’s largest steel producer, has the smoggiest cities in China. The air quality of neighbouring Beijing is also one of the worst in the country.

Since mid-November, as a new round of heavy smog struck most of China, several provincial governments launched sweeping environmental crackdowns and shut down steel mills that have violated environmental laws across Hebei, Jiangsu, Shandong, and Sichuan provinces.

The Ministry of Environmental Protection also recently sent inspection teams to Beijing, Shanghai, Guangdong, Chongqing, Hebei, and other regions to check if local governments and companies had complied with environmental protection rules.

In addition, China is embracing President Xi Jiping’s “supply-side reform” and has intensified its efforts to cut capacity in crowded sectors such as coal and steel.

This has led to a surge in coal prices, including the met coal used in steel making. Subsequently, Chinese steel mills have “rushed to purchase” higher grade iron ore to make steel production more efficient, said Liu Jin, an analyst for China’s Cofco Futures Group.

“We expect (iron ore price to have) a strong start to 2017,” the JP Morgan analysts said. “Short-term drivers are likely to remain at play in the first quarter of 2017, which should see volatility continue,” they said.

However, as 2017 progresses they expect prices to soften from current levels as the market digests the oversupply and coal prices ease.

Short-term drivers are likely to remain at play in the first quarter of 2017, which should see volatility continue
JP Morgan analysts

JP Morgan predicts the global iron ore industry will have approximately 58 million tonnes of oversupply in 2018, before the market starts to look more balanced in 2019 and 2020.

Goldman Sachs analysts anticipate iron ore prices to stay above US$60 per tonne during the first half of 2017, citing three reasons.

First, steel consumption is more resilient than expected and demand for iron ore is likely to be supported further by incremental restocking across the steel supply chain.

In particular, “on the demand side, while real estate investment in China is expected to decelerate

modestly in 2017 after the strong price and sales gains in 2016, continued strength in infrastructure investment and heavy machinery production are likely to persist”, they said.

Second, the pace of supply growth has slowed due to delayed capital expenditure and operational challenges.

Third, capital flows into the iron ore market are likely to support prices as long as they provide speculative investors with a hedge against a weaker Chinese yuan, as Goldman expects the Chinese currency to depreciate another 5 per cent in 2017.

However, in the second half of 2017 rising supply should begin to weigh on iron ore prices “as the inventory restocking process runs into physical constraints and market behaviour starts to reflect the downside price risk of an eventual contraction in Chinese steel demand”, they said.

Therefore, Goldman forecasts iron ore prices to pull back to US$55 per tonne by the end of 2017.

business-article-page