Canary In The Iron Pit: Price Destruction From Massive Iron Ore Glut Gains Momentum

The worldwide money printing spree by central banks since the mid-1990s has produced a profound deformation of the commodity space. In the initial round, credit-fueled excess consumer demand in the DM world caused an enormous increase in consumption of industrial materials, leading to sharply rising prices.

As shown below, copper broke out of its $0.80/lbs. channel and eventually soared to $5. Similarly, iron ore had long been priced at around $20-25 per ton, but owing to the global consumption and industrial production boom of the last two decades it quickly climbed through $100 per ton and never looked back. By the 2012 peak it reached nearly $200 per ton—or a level 10X its historic norm.

Yet the spectacular trends shown in these graphs do not represent some unalloyed victory for “economic growth”, global capitalism or the liberation of Asian peasants from the un-monetized world of subsistence farming. All three of these notions are good things—but they got vastly and destructively overdone by statist economic policies. Nearly everywhere in the world after 1994, governments went all-in for massive credit expansion, heavy mercantilist trade subsidies and currency pegging and a historically unprecedented wave of investment in industrial and public infrastructure based on the availability of deeply subsidized, uneconomic capital.

Iron ore retreated to the lowest level since 2012, capping a fourth weekly loss and nearing $100 a ton, as increased seaborne supplies of the steel-making raw material boosted a global glut.

Ore with 62 percent content delivered to the Chinese port of Tianjin fell 1 percent to $102.70 a dry ton, the lowest level since September 2012, according to data from The Steel Index Ltd. The commodity dropped 23 percent this year, after falling 7.4 percent last year.

Iron ore entered a bear market in March as the world’s biggest mining companies including BHP Billiton Ltd. (BHP) expanded output from low-cost mines in Australia, betting that rising exports to China would more than offset lower prices. The commodity may decline below $100 going into next year as the surplus builds, Goldman Sachs Group Inc. said this week.

“We expect prices to go below $100 before the end of the year,” Ivan Szpakowski, a Hong Kong-based analyst at Citigroup Inc., said by phone today, forecasting averages of $102 for the third quarter and $100 in the final three months. “The biggest factor is probably still supply-side.”

Shares of BHP, the world’s third-largest iron ore exporter, fell 0.8 percent to A$37.34 at the close in Sydney, while Rio Tinto Group (RIO) declined 0.8 percent to A$60.95 and Fortescue Metals Group Ltd. lost 0.2 percent to A$4.81. In Brazil, Vale SA, the biggest exporter, declined 1.5 percent yesterday, taking this year’s retreat to 18 percent.

The global surplus will jump from 14 million tons last year to 77 million tons in 2014 and 145 million tons in 2015, Goldman Sachs said in a May 7 report. The increase led by new, low-cost output from Australia and Brazil will displace higher-cost supplies in China, Michiel Hovers, vice president of iron ore marketing at BHP, said at a conference in Singapore this week.

Prices of less than $100 a ton are too bearish, Claudio Alves, Vale’s global director of marketing and sales, told the same conference. Long-term prices are unlikely to go below that level, he said.

While spot prices could easily trade below $100 for a short time, they aren’t expected to maintain a six to 12-month average below that level for 12 to 18 months, said Lachlan Shaw, an analyst at Commonwealth Bank of Australia. A significant amount of high-cost Chinese capacity is still needed over the next year or two to meet China’s steel demand, Shaw wrote in an e-mail.

Operating costs at about 80 percent of China’s domestic iron ore mines are $80 to $90 a ton, according to Xia Yang, a Shanghai-based analyst at Mysteel, China’s biggest steel researcher. That compares with A$39 ($37) for Rio Tinto, A$41 for BHP and A$56 for Fortescue, according to UBS AG.

China’s imports jumped 24 percent to 83.4 million tons last month, figures from the customs administration showed yesterday. The country, the world’s largest steelmaker, and accounted for 68 percent of global shipments last year, Goldman estimates.

Iron ore dropped for a fifth month in April as stockpiles at ports increased, economic growth in China slowed and the government tightened credit. Gross domestic product is projected to expand 7.3 percent this year, according to a Bloomberg survey, compared with China’s official target of about 7.5 percent.

Steel production growth in China may slow to single-digit rates as mills face tight credit conditions as well as stricter environmental measures, according to Wang Xiaoqi, vice president of the China Iron and Steel Association. Steel output is expected to grow 3 percent to 4 percent this year and in 2015, Vale’s Alves said.

BHP last month raised its full-year production guidance to 217 million tons, while Rio Tinto reported record quarterly output. Fortescue (FMG) completed an expansion to almost triple capacity to 155 million tons.

“Early signs of a structural surplus are already evident,” Goldman analysts Christian Lelong and Amber Cai wrote in the May 7 report. “The Chinese cost curve will not prevent seaborne iron ore prices from crashing through the $100 level going into 2015.”

View original post at Bloomberg.