Cooling the market for now
The iron ore price has been volatile in recent months, retreating swiftly from the June record high of US$228 a tonne, retracing by some 55% to trade down to US$102 per tonne earlier this month, before recovering back to US$115 a tonne presently. Amongst several concerns that impacted on the price, were fears of slowing Chinese demand, with home sales in the country falling heavily in August, and authorities intensifying steel production curbs to improve air quality, and as the Beijing 2022 winter Olympics draws nearer. These fears were amplified by Evergrande solvency concerns and the broader implication a potential collapse could have on China’s property market and financial system. The following chart shows the one year iron ore price (63.5% iron content for delivery to Tianjin):
Source: tradingeconomics
As Members can see from the above chart, the price is, however, now retesting the US$118 per tonne ceiling, as fears of an Evergrande collapse receded and especially as The People’s Bank of China (PBoC) pumped US$17 billion in short-term funding back into the banking system. It is the actions of the PBoC that provides the clues, we believe, for future price movements in iron ore.
The global economy remains on course to complete a “V” shaped recovery from the COVID 2020 economic lows. Positive data reads across the globe, reinforced by vaccine driven reopening economies, are providing the impetus. The following chart shows the global forecast for Gross Domestic Product (GPD) growth:
Source: World Bank
The arrival of COVID-19 in 2020 brought with it a cascade of government spending and other quantitative measures in response, as can be seen in the above chart, to collapsing GDP numbers for 2020. Estimates have global government spending to stimulate economies in the range of US$14 trillion to US$17 trillion, with the United States spending estimated at US$5 trillion. This spending and maintaining accommodating interest rate environments, by many central banks, is having the desired effect on global GDP. We certainly agree with this scenario playing out, for global GDP, over the remainder of 2021 and into 2022.
The Chinese experience has been very similar to that globally, with stimulatory spending and low interest rate settings stirring China’s GDP. The following chart shows annual GDP growth on a quarterly basis:
Source: tradingeconomics
The International Monetary Fund (IMF), in July 2021, revised down its forecast for China’s GDP by 0.3 percentage points, from earlier forecasts, to 8.1% for 2021 and slowing to 5.7% in 2022, which remained unchanged. This downward revision in GDP for 2021 does not, in our view, warrant the correction in the iron ore price as experienced in recent weeks. Particularly as the forecast for GDP growth for 2022 is still solid. The economic framework for the remainder of 2021 and for 2022 looks, in our view, supportive to China’s steel sector remaining robust.
For the 12 months to August 2021, China produced a 1.1 billion tonnes of crude steel, representing a 6.9% increase year-on-year (yoy) and this remains near record highs of 1.11 billion tonnes. The following chart shows 12 months of annual Chinese crude steel production monthly:
Source: World Steel Association
Certainly, this growth rate is pointedly higher than the annual 2.0% growth in crude steel production that we had forecast for 2021. The forecast recovery in 2021 global GDP of 5.8% growth bodes well for Chinese steel production, given the current growth trend. This is a significant result, given global GDP growth for 2021 is now expected to accelerate at a faster pace of growth than many had forecast, and should sustain better steel production forecasts for 2021 and beyond.
We expect China’s steel industry will, with stimulatory spending continuing to flow into infrastructure projects and rippling across the global economy, continue to expand but at a slower pace. We expect Chinese crude steel production will slow from the breakneck 6.9% pace set in August 2021, to around 5% growth to calendar year-end hand is unchanged, to deliver a record 1.15 trillion tonnes, or around 70,000 tonnes more than we expected for the full year.
Iron ore is a key ingredient in the production of crude steel and China’s appetite did wane in the past few months but has returned in August 2021. The following chart shows 12 months of Chinese monthly imports of iron ore:
Source: China Customs
For August 2021, China imported a 97.5 million tonnes of iron ore, to print a fall 2.9% yoy. Annual growth has slowed to below our forecast annual growth rate of 1.5% in iron ore imports, but on August 2021 numbers and going into the end of the calendar year, we expect monthly imports of iron ore will improve on our steel outlook. August monthly imports were impressive month-on-month, increasing by 10.2%. The jump in August imports directly reflects the fall in iron ore prices, as mills look to improve operating margins on falling input costs.
We expect Chinese iron ore imports will return to the 1.5% annual growth we forecast for 2021, from the negative 2.9% reported for August 2021. Under this scenario, we expect to see China import 1.2 trillion tonnes of iron ore and remain at close to record pace for 2021. With the scenario for China’s steel industry and with that iron ore, thanks to ongoing global government spending initiatives, looks set to remain positive for 2022. We expect China will import a record 1.3 trillion tonnes of iron ore in 2022. China produces around 60% of the world’s supply of crude steel and is head and shoulders above the next supplier in India at 5%n, so where China steel goes, so too do the fortunes of iron ore, and this outlook remains modestly positive.
COVID-19 was a global curse on everything, but the remedies to repair the economic damage it caused, has been a boon for the iron ore price. Going forward, we can see the iron ore price again retesting record highs in the next few years. For 2021, we have lowered our price forecast and see iron ore trading in a range of US$155 a tonne to US$160 a tonne (previous US$185 to US$190 a tonne) by calendar year-end. The mid-range of US$157.50, reflects a modest 8.1% rise on the 2021 year-end price. We expect prices in 2022 will also remain robust, as the ripple effect of infrastructure spending affects the year.
We recently introduced Fortescue into the portfolio on the view that the share price had corrected enough from its record highs to reflect our longer term view for iron ore. Fortescue has used the period of a stronger iron ore price to establish a very good balance sheet capable of supporting its future growth initiatives. Fortescue remains a buy for Members with no exposure to the stock.
The capitulation in the share prices of BHP (ASX:BHP) and Rio Tinto (ASX:RIO), in the current correction, provide an opportunity for Members without exposure to each stock to acquire exposure. We expect both BHP and Rio Tinto will report softer financial results to the end of December 2021 (both will report in February 2022), but the bars to reflect these results have been set to low in the current correction. BHP especially, with the sale of its petroleum operations progressing, looks set to refocus on its successful iron ore operations.
Consequently, we have upgraded our recommendations for both BHP (ASX:BHP) and Rio Tinto (ASX:RIO) to a buy for Members with no exposure to each stock.
Disclosure: Interests associated with Fat Prophets hold shares in BHP (ASX:BHP), Rio Tinto (ASX:RIO) and Fortescue.
