Bulk Buys: It’s a ‘pivot toward positivity’, but will China’s Covid shift actually light a fire under iron ore?
Link copied to
Looking for an early Christmas present, iron ore investors?
Look no further than the Chinese Communist Party’s 20-point Covid Plan and 16-point property rescue package which has, if nothing else, brought some optimism back to the sector.
Attitudes towards China’s economic growth had gotten pretty bearish in the weeks since the CCP’s National Congress, where the reinstatement of leader Xi Jinping seemed to bake in its hardline Covid-Zero approach.
But the shock reversal has brought some optimism back to a space crying out for a source of light after iron ore prices dipped below US$80/t last month for mid-grade fines and below US$70/t for low grade fines, making some smaller producers extremely marginal.
Is this policy change a genuine shift in China’s approach? Experts seem to think it’s a start.
“This points toward to a fundamental realisation in the Chinese Communist Party that the policies which they have been strictly implementing in the past three years cannot be sustained indefinitely,” Fastmarkets Asia ferrous editor Paul Lim told Stockhead
“This also happens after the national congress meetings, which indicate that Xi Jinping’s new leadership cadre has brought new thinking and persuasion to the table, realising now that the longer they hold out, the worse citizens’ lives will be and the weaker the economy will be.
“So this is a definite pivot toward positivity, and likely the start of a trend toward economic recovery, which has caused iron ore to jump today because the downstream steel industries will benefit from it.”
We’ve already seen ASX investors get excited about the news, sending bellwethers Fortescue Metals Group (ASX:FMG), BHP (ASX:BHP) and Rio Tinto (ASX:RIO) sharply higher on Monday.
One big negative of any rebound in iron ore prices is that it will make things significantly harder for steel producers to turn a profit. And profitable steel factories are the best customers for any iron ore producer.
They are already operating at loss-making levels of up to 200-300 Yuan per tonne, between ~US$28-42.
Finished steel prices would need to rise by at least that much to get them into the black, Lim said.
“Production has already been tapered heavily, and I do not feel more production will stop in the coming weeks, especially as the Lunar New Year will start earlier than usual in 2023, and restocking is still necessary,” he said.
“The market generally feels the worst is over, and that the recent signs by China about supporting the real estate industry and fine-tuning its Covid-19 policies is taken very positively by the market.”
But the price run remains 100% based on speculation and sentiment, Lim said.
Chinese data yesterday again painted a devastating picture of the impact of Covid on the economy in October, with retail sales actually down 0.5% on last year.
Industrial output growth was down from 6.3% in September to 5% last month.
“The economy will also continue to face headwinds from cooling global demand and property market woes,” Capital Economics economist Zichun Huang said.
“Policymakers are stepping up support – for example, they have made it easier for lenders to rollover credit to developers.
“But with confidence in the housing market and wider economy still low, we think more policy action is still needed to revive subdued credit growth.”
Lim said downstream consumption figures for real estate, manufacturing and machinery were yet to pick up.
“Go into the spot market today and you will not find a single steel mill looking to increase its iron ore purchasing volumes significantly, as their downstream steel sales are still poor,” he said.
“They may try to increase their list prices for their steel, but whether that works depends on whether buyers bite.”
It wasn’t that long ago that iron ore prices hovered above US$100/t, with benchmark 62% Fe fines trading at US$98.50/t as recently as October 10.
Monday’s spot price of US$94.58/t was the highest since October 14, ahead of the recent national congress in Beijing, where China’s politburo confirmed its commitment to the Covid Zero policy.
Despite the positivity in recent days, Lim says demand fundamentals would need to improve to see a further rise in iron ore prices.
“This is slightly more possible now if real estate companies are able to get themselves together, start generating cashflow and pull themselves out of debt with whatever aid is given to them,” he said. “But they’re running on borrowed time, and it will take awhile more to see who remains solvent and remains a viable business.”
Alternatively, an end to the war in Ukraine, which would prompt a major rebuilding mission a number of companies are positioning themselves for, could provide a demand shock down the line.
“(Increased Ukrainian demand for Chinese steel) is possible because … Azovstal and Illyich steel plants (were) destroyed or heavily damaged,” Lim said. “This would then be a supporting factor for iron ore prices.”
Another indicator of strength in steel markets is the spread of prices from high grade to low grade fines.
In bull markets high grade fines tend to extend their premium over the 62% index because steel producers have the margins to prioritise higher quality iron ore, which carry a lower emissions intensity.
Lim says premiums are coming off a low base of US$10-11/t in what he says has been a “dismal year” for the high grade segment of the market, with a return to higher splits of US$20/t unlikely because most mills have already hit their emissions reduction targets.
“This is because many steel mills have achieved the required levels of emission required by the MIIT, and are no longer required to undergo sweeping restrictions,” he said.
“There’s also an abundance of high-grade fines in the spot markets – sellers are finding it very difficult to find buyers, and Vale (the world’s major producer of 65% fines) will likely try to keep shipments up toward the end of the year in order to hit their production guidance of 310-320 million tonnes.”
Thermal coal prices ticked up yesterday after a month of declines, brought about among other things by a milder than expected start to the northern winter and better than anticipated gas supplies in Europe.
They remain extraordinarily high, with Trading Economics assessing Newcastle coal above US$330/t yesterday, enough for our Aussie coal execs to buy themselves a yacht or two.
Coking coal futures had been catching up to their thermal cousin, closing what was once an unusual US$150/t plus arbitrage which saw energy coal traded far higher than the traditionally premium hard coking coal market.
There were few winners in the coal market over the past week, with prices generally trending down and sideways, though still at ultra high levels.
At the big end of town, BHP boss Mike Henry and chairman Ken MacKenzie confirmed the world’s biggest miner’s commitment to coking coal, telling shareholders at their AGM last Thursday in Perth that it would be a major component of steelmaking for decades.
Meanwhile, something a little different at the small end of town. Allegiance Coal (ASX:AHQ) has fallen 86% year to date after running into operational trouble at its operations in the United States.
Many of its issues, particularly at the New Elk mine in Colorado, have been down to labour availability.
It thinks there could be a light at the end of the tunnel there. It hopes the overhaul of a continuous miner at the underground coal seam could deliver a return to benchmark expectations at the under-producing mine.
AHQ is hopeful recent changes to the labour market and the exit of the mine’s general manager and superintendent by mutual agreement, could deliver a change in fortune.
“Two underground coal mines have recently closed down in neighbouring New Mexico and Utah from which we are targeting to recruit available mine workers. We have also entered into supply arrangements with labour hire companies to recruit workers,” the company said in an operational update yesterday.
“We have set up a shift roster with a view to engaging workers on a 7-day on and 7-day off cycle to allow them to work at the mine but also to remain living at home, a roster structure preferred by many.
“In addition to the above, with a change in leadership we have had some workers who had left return to the mine to work and we are hopeful we will see more return.”