Winter of discontent ahead for Australian iron ore miners

FMG chairman Andrew Forrest praying for a higher iron ore price

FMG chairman Andrew Forrest praying for a higher iron ore price

Michael Sainsbury

China must be now be extremely concerned about its property market plummeting with a story widely published in state media at the weekend going to great lengths to say that if the property bubble does pop – and note that the story actually calls it a bubble – it won’t hurt the economy.

“It can be said that China’s property bubbles are now the biggest risk in its economy, but bearish talk of a collapse of the whole economy smells of ulterior motives,” Wang Xiaoguang, a researcher at the Chinese Academy of Governance, told state run news service Xinhua.

The story also noted that “in March, of a statistical pool of 70 major Chinese cities, 14 saw home prices either decline or stagnate on a monthly basis, the highest figure since early 2013. The average growth rate of the cities dipped to the lowest level for the past 15 months.”

In spite of the increasing risks the story posited that a full-blown property meltdown was unlikely, calling those foreseeing a crash in the whole economy “doom-mongers”.

While that looks increasingly hard to swallow – and it’s unclear quite what the clearly paranoid talk of “ulterior motives” is – any popping of the bubble will certainly hurt the Australian economy. About 60% of steel produced in China (each tonne contains 1.7 tonnes of iron ore) is used in said property market.

Iron ore stockpiles at Chinese ports remain at record highs of more than 100 million tonnes and the iron ore price continued its drift downwards last week, closing on Friday at US$110 per tonne for the benchmark 62% fines at Tianjin port. That’s at the very bottom end of the range (US$110-US$120) that Fortescue Metals Group has forecast for the year with many pundits now saying that prices are heading even further south. The iron ore price was down 4.7% last week, today Mysteel 62% index closed at $109.5 down $1.75.

More problematically for FMG, the price differential between the 62% benchmark which is the price for high quality ore mined by Rio Tinto and BHP Billiton and the lower 58% benchmark which is closer to the quality of FMG’s ores, has widened since the beginning of the year from about 1% to about 4.5%. This is an indication that as supply increases steel mills will opt for higher quality ores, further reducing the price that FMG receives against the 62% benchmark.

If the commodities booming futures markets are any indication, markets believe that the price has further to fall, last Friday iron ore futures for the 3rd quarter this year were US$107 and for next year US$105. At those prices FMG will be lucky to be getting an average price of US$100 for its iron ore. This would be down from an average price of US$107 for the first quarter of this year.

FMG’s share price showed just how sensitive it is to the price of iron ore today (April 28) falling A$0.22c to A$5.12, down 4.16%. Rio Tinto’s share price, on the other hand, only fell 1.46%. Rio’s costs are at least US$20 per tonne lower than FMG’s.

Iron ore prices are now running at about US$20 per tonne below the level they were at this time last year, reflecting the surging supply that is hitting the market at a time when the Chinese economy continues to stutter. GDP for the first quarter was 7.4% down from 7.7%.

Looking forward, it appears demand for steel at the start of China’s peak construction season which runs from April-June and then September-November is soft.

In a preview of its monthly on the ground survey of the Chinese steel market J Capital Research managing director Tim Murray said that the vast majority of steel traders had reduced inventory by up to 40% due to tighter financing and negative outlook for sales.  He said, in general traders have low expectation of price increases for steel in the peak season and most are expecting price increases of less than 3% due to poor continuing demand.

Fresh iron ore supply in 2014 has been estimated at about 170 million tonnes, implying increased Chinese steel production of 100 million tonnes for the commodity to stay at the same price.

But this is a jump of almost 13 % on last year’s official production figure of 780 million tonnes. With GDP likely to grow somewhere between 7-7.5% this year and even the most bullish estimates of steel production in China this year increasing at just 4% (some like Murray believe production will be pretty flat) it’s easy to see why the iron ore price is falling. Now, it’s really just a matter of how far.

You can read an example of China’s state media’s full protestations about the country’s property sector in the piece below.