FOCUS: HRC vs iron ore – who is leading whom?

Steel market participants often identify iron ore as the key driver of steel prices because mills typically formulate their pricing strategies based on raw material costs - but this appears to have changed in 2020.

While some unique challenges have emerged this year due to the Covid-19 pandemic, one development that stood out from the rest is this: Iron ore market participants have attributed the sharp price increases in the steelmaking raw material to the downstream steel market instead, in particular that for hot-rolled coil, the darling steel commodity that has outshone other products.

Who leads who?

The correlation between Chinese HRC prices and those for imported iron ore has strengthened significantly so far this year in comparison with the last two years.

In the third quarter of 2020, this correlation intensified in September after weakening in August.

An indication closer to one or minus one suggests a stronger correlation while those closer to zero suggest a weaker correlation.

Fastmarkets’ daily price assessment of steel hot-rolled coil domestic, ex-whs Eastern China was 3,820-3,840 yuan ($561-564) per tonne on Monday September 28 after falling from a 22-month high of 4,090-4,090 yuan per tonne on August 18.

Iron ore prices move in a similar pattern in August and September.

Fastmarkets’ index for iron ore 65% Fe Brazil-origin fines, cfr Qingdao stood at $128.50 per tonne on September 28, down by 10.3% from a year-to-date high of $143.30 per tonne on September 7.

Fastmarkets’ index for iron ore 62% Fe fines, cfr Qingdao was at $116.15 per tonne on September 28, down by 10.8% from September 14’s $130.17 per tonne, the highest so far this year.

Chinese support
Chinese steel prices have bolstered those for iron ore for most of this year, market sources told Fastmarkets.

“It’s sometimes hard to tell whether raw material or end product is the main price driver of the other. This year, I believe that it is mainly steel prices driving iron ore prices,” a Shanghai-based trader said. “There’s hardly any reason other than steel demand that spurred iron ore price growth.”

The economic slowdown triggered by the Covid-19 pandemic would have caused iron ore prices to fall were it not for the strong demand from Chinese steel mills, the trader continued. This is unlike the tight supply situation in 2019, when the collapse of one of Vale’s tailings dams in Brazil caused prices to surge.

China imported 9.95 million tonnes of steel in the first seven months of this year, up by 49.3% from a year earlier, according to Chinese customs data.

China’s crude steel output was 593.17 million tonnes in the same period, up by 2.8% year on year, according to the National Bureau of Statistics.

“That happened while most other countries struggled to clear domestic steel stock,” the Shanghai-based trader said.

“China’s iron ore market fundamentals remained stable, and expectations of strong demand for steel caused more value to be priced into iron ore,” a trading source in southern China who deals in steelmaking raw materials said.

Breakout star
The Shanghai-based trader believes HRC was the largest driver of prices for iron ore after April. Before then, rebar was the biggest driver, he said.

“China increased efforts to revive the construction and infrastructure segments from March onward after the Covid-19 pandemic was brought under control. This caused rebar demand and prices to surge,” he said.

But this resulted in a supply shortage of HRC and caused prices to increase, especially in eastern China.

Fastmarkets’ daily price assessment for steel hot-rolled coil domestic, ex-whs Eastern China surged several times after bottoming out on April 2 at 3,150-3,190 yuan per tonne.

“China’s steel producers increased HRC output then, which also bolstered iron ore consumption rates,” the trader in Shanghai said.

The correlation between HRC and iron ore prices reached highs of 0.96 and 0.95 for iron ore 65% Fe Brazil-origin fines and 62% Fe fines respectively, especially in the March-May period, and was stronger than that between rebar and iron ore prices.

A Singapore-based flat steel trading source agreed with his counterpart in Shanghai, saying that iron ore market participants had been bullish about prices in anticipation of the peak steel demand season of September-October.

Turning point?
But sentiment in the HRC market deteriorated in late August due to lower-than-expected demand.

“Market participants realized that the outlook for HRC demand in the rest of the year was over-optimistic, and this caused iron ore prices to start falling,” a buyer source in southern China said.

“Orders for September- and October-delivery steel products from end users were lower than expected, and concerns remain over stock levels increasing after China’s October 1-8 holiday [to mark its National Day]. This caused iron ore prices to slump,” he added.

But the strong correlation between prices for iron ore and HRC remains.

“Prices of both products declined, although iron ore producers are probably happy that their prices aren’t falling as fast as HRC’s,” a second Shanghai-based trader said.

The correlation between Fastmarkets’ price assessment for HRC in eastern China and the index for iron ore 62% Fe fines, cfr Qingdao was 0.75 in September, lower than that in May and July.

In August, the correlation was 0.08, which suggested a short-term “decoupling” between HRC and iron ore prices.

“Iron ore demand hasn’t fallen significantly because most steel producers are maintaining output despite falling prices. If steel mills had lowered output, then iron ore prices would have fallen faster,” the trader said.

Brazilian supply

While market participants believe that the supply shortage of Brazilian iron ore had partly bolstered prices from April, this factor is fading.

A second Singapore-based trader said Vale’s iron ore supply recovered significantly in September, which led it to issue more offers to the spot market than previous months.

“Shortly after China’s steel prices surged, especially those for HRC, Vale increased its output significantly to ensure sufficient supply to the market and to profit from the high prices.

“But with these increased shipments, concerns over Brazilian supply have eased. Along with this, iron ore prices could be depressed further in the months to come,” he said.

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