The demise of the iron ore price has been repeatedly predicted but has failed to materialize over the last few months. Miners line up to announce strong sales and yet repeatedly voice notes of caution that excess supply could overwhelm the recovery.
Yet the market continues to be confounded by not just a rising iron ore price, but continued strength in Chinese steel prices and a wider strength in metals prices.
Several factors are feeding this robust performance and it will take a reversal of one or more factors to spark a change in direction of metal prices.
The dollar has been surprisingly weak this year. Measured against its main rivals, such as the euro, the dollar index has depreciated more than 9% in 2017, according to the Financial Times, and it is within sight of breaking down to a level last seen at the start of 2015.
The dollar began the year at a 14-year high and the Federal Reserve has tightened overnight borrowing costs twice in 2017, which has been bullish for metals that enjoy an inverse relationship to the value of the dollar.
Meanwhile, commodities generally are supported by strong equity and GDP growth. Across the board, both global GDP and equities have performed well this year.
True, some have flattered to deceive. U.S. markets have been supported by high levels of buybacks last year, although that has tailed off this year – sometimes a sign of an impending downturn. Some have come off a low base, like Russia and Brazil, that have been in severe recessions and are only now making a lukewarm recovery. Emerging market index growth has been skewed heavily to China’s growth — even so, markets take comfort from a broad-based recovery.
China in the Driver’s Seat
But the biggest driver has been China. Iron ore in particular has been both physically and speculatively supported by robust steel production and the fear among buyers that environmental controls will shutter steel production this year (particularly during the coming winter months).
Steel rebar prices have led the way, stimulated by good demand but less obviously driven by the widespread closure of “illegal” steel production. By some estimates this has taken up to 100 million tons of production out of commission, creating a bonanza for “legal” integrated producers of the product. The rise in rebar prices has been taken as a proxy for strong steel demand, although in large part it is probably as much a switch to a different production route. However, the switch to iron-ore-based integrated steel production will certainly have boosted iron ore demand at the expense of steel scrap.
As if the market needed any more stimulus, last week’s 6.5 magnitude earthquake in Sichuan province, while tragically killing at least 20 people and injuring hundreds more, has had the effect of boosting steel prices further in the expectation reconstruction will drive further demand.
Apart from a possible severe escalation of tensions between the U.S. and North Korea into some form of open conflict, it seems unlikely there will be a reversal in these broadly bullish trends anytime soon.
That is not to say we cannot expect a correction in iron ore or dollar trends in the short term, but a number of factors will need to coordinate to sap the market’s current enthusiasm for firmer prices.
We are not calling this a long-term bull run, as there are too many question marks over the direction of the dollar, equities and oil. But, for now, solid GDP and Chinese demand versus fears of Chinese supply side cutbacks this winter seem to be underpinning a broad-based recovery in metal prices.