Iron ore and steel forecast and analysis Q3 2016

Each quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – the latest are Sucden Financial Metals Reports for July 2016.

Below is the iron ore and steel report. To download a PDF copy of the full report, please click here.

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Iron Ore and Steel – Stronger than justified

Summary

Iron ore’s rollercoaster ride continued in the second quarter but it seems to have stabilised in June around $50-55 per tonne. This is well above the December low of $38.30 but below the April high around $70, which was partially driven by high-volume speculative buying. Since there is no shortage of iron ore or new capacity, prices look likely to establish a range between $48 and $60, with the higher levels seen during periods of restocking. Because the raw material has become a volatile commodity, we would look to take advantage of moves outside of this range, especially into strength.

Iron ore and steel price chart 2007-2016 - FastMarkets Metal report Q3 2016 Iron ore table - Chinese iron ore required to balance the market - FastMarkets Metals report Q3 2016

Overall trend – The rise in iron ore prices was driven by a classic restocking rally that then attracted speculative buying by Chinese retail investors. But prices have since corrected – they are holding up relatively well around $50-55. Fundamentally, they could fall further but there is still potential for restocking and speculative bargain hunting. Unless there is a surprise and sustainable recovery in China’s economy, the path of least resistance should be to the downside. On balance, we would look for prices to work their way back to $48 and over the longer term to $45.

No shortage of seaborne iron ore supply – Falling prices in recent years have cut some 250 million tonnes of production: 150 million tonnes from China and 100 million tonnes from other suppliers to the seaborne market. But the main producers have increased output by some 300 million tonnes over the past three years or so and further additions are expected in 2017 and 2018; these will have to displace existing capacity, which is only likely via price pressure. With Chinese steelmakers facing more anti-dumping legislation, domestic steel production may have to be reined in, which could weaken demand for iron ore. If reduced Chinese steel exports are balanced by increased western steel production, iron ore might lose some market share to steel scrap. Overall, excess iron ore capacity and price-elastic production should mean rallies are short-lived.

Government curbs speculation – In the April report, we highlighted the pick-up in speculative activity on Chinese iron ore and steel futures markets. In May, the government put pressure on exchanges to curb speculative activity by increasing initial margin payments, which seems to have worked – prices have retreated and volatility has declined. This should now lead to a period where prices better reflect the fundamentals. For iron ore prices to rise, steel production rates must increase; in the absence of that, excess supply is likely to keep prices under pressure.

Steel production leaps higher – Steel output tends to jump in March most years – this is when the end of the winter months and the start of a stronger construction period fuel restocking. But the leap in production in March this year was quite spectacular and was given a boost by speculative buying, which lifted prices and in turn attracted more production. Output climbed 9.7 percent in March-May 2016 from the preceding three months; the comparative rise a year earlier had been 4.4 percent. Falling prices and a depressed outlook had led to destocking so there was a risk of restocking; better Chinese data in the first quarter prompted a restock that triggered the increase in production. But we would not expect such a restock to cause a 70-percent rise in steel rebar prices on the Shanghai Futures Exchange or the 84-percent rally in iron ore prices from the January low of $38 to the April high of $70. The excessiveness of the rallies was due to the speculative buying frenzy.

Regional prices rise but Asia has since corrected – Hot rolled coil (HRC) prices also climbed in North America and Europe and are holding up well, partly because Chinese exports have been reined in by anti-dumping calls and also due to continuing restocking. As the chart below shows, with Asian steel prices having corrected and price differentials expanding, Europe and North America are likely to be attracting imports if not from China then from Russia, Korea and Taiwan. So we would expect steel prices to consolidate at lower numbers.

After the restocking run, iron ore prices likely to remain under pressure – The restocking run in China has seen iron ore stockpiles climb to 100.65 million tonnes – levels not seen since December 2014, such has been the extent of the restocking. With prices falling again, destocking is now likely, which will put further downward pressure on iron ore prices. In the third quarter, we expect prices to trade in the $48-60 range.

steel chart - regional steel prices HRC 2014 - 2016 - FastMarkets Metal report Q3 2016

Steel prices rallied strongly in the first quarter; prices are now showing more divergence regionally. The question now is whether US and European prices follow Asian prices lower – it seems likely that they will.

Iron ore chart - Chinese prot stocks - 2010 - 2016 - FastMarkets Metal report Q3 2016

Iron ore stockpiles at Chinese ports have climbed to just above 100 million tonnes, the highest since December 2014. Rising prices, after an extended period of destocking, have attracted more of the raw material into China.

Iron ore chart - movement in forward curve - FastMarkets Metal report Q3 2016

The iron ore swap forward curve flattened into the price sell-off but became more backwardated into the rebound. The forward curve lines up with our price forecast.

Steel chart - global steel output - FastMarkets Metal report Q3 2016

Global steel output trended lower in 2015 but it has jumped this year due to restocking. Higher prices also encouraged producers to increase output. Much of the increase has gone into inventory rather than for consumption.