Asia | China | Commodities | COVID
Iron ore prices have risen strongly over the past month, continuing a trend that began over summer. However, prices now far exceed those implied by a symmetric recovery from the Covid demand slump. Now up nearly 40% YTD, iron ore prices have outperformed both industrial and non-industrial commodities in 2020 (Chart 1). Indeed, iron ore prices are increasingly an outlier, although energy prices have recently begun to catch up.
While there have been some Covid-related supply issues this year, they have been too small to impact prices significantly. The ‘Big Four’ producers – Vale, Rio Tinto, BHP and Fortescue – did experience some interruptions. But the big supply-side development this year has been a shift towards new production in places as diverse as Ukraine, Canada, Chile and Liberia, which in aggregate has adequately filled any temporary gaps from the majors.
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Summary
- Recovering steel production has pulled iron ore prices sharply higher.
- De-stockpiling appears to have begun, capping further price gains near term.
- The Baltic Dry Index (BDI) has fallen sharply.
- In coming months, the iron ore and BDI disconnect will likely close.
From Recovery to Boom? Or Bust?
Iron ore prices have risen strongly over the past month, continuing a trend that began over summer. However, prices now far exceed those implied by a symmetric recovery from the Covid demand slump. Now up nearly 40% YTD, iron ore prices have outperformed both industrial and non-industrial commodities in 2020 (Chart 1). Indeed, iron ore prices are increasingly an outlier, although energy prices have recently begun to catch up.
While there have been some Covid-related supply issues this year, they have been too small to impact prices significantly. The ‘Big Four’ producers – Vale, Rio Tinto, BHP and Fortescue – did experience some interruptions. But the big supply-side development this year has been a shift towards new production in places as diverse as Ukraine, Canada, Chile and Liberia, which in aggregate has adequately filled any temporary gaps from the majors.
Even as global steel production and the prices of most industrial commodities slumped through the middle of the year, there was never a large decline in iron ore prices due to stockpiling, particularly in China. Only in November did these stockpiles begin to decline, as steel production ramped up. Given high prices, a moderate destocking is likely to continue into 2021, which should limit further price gains in the near term. That said, as steel mill margins remain elevated, a large downward price correction appears unlikely. Most probable is that, as stockpiles are worked off, over the coming months prices settle back toward the H2 range of around 120 $/tonne.
One indication that de-stockpiling is now effecting the market is the large disconnect that has appeared between iron ore prices and dry bulk shipping rates (Chart 2). Although it recovered from the initial Covid slump by mid-year, the BDI has recently declined again to nearly 1100. While that is close to the BDI average of the past few years, it is way out of line with the ongoing rally in iron ore prices. But assuming that de-stockpiling is largely completed over the coming months, a modest recovery in the BDI is likely before the end of Q1.
A key question going forward is whether final steel demand will continue to increase at the rates generally seen pre-Covid. While it has recovered in China, production in the rest of the world has only just begun to increase again. Much depends on whether the various government stimulus programmes under discussion will include meaningful housing and infrastructure support. If so, this would make it more likely that iron ore prices remain elevated during 2021, with the BDI closing the gap higher, instead of iron ore declining back in line with the BDI.
John Butler has 25 years experience in international finance. He has served as a Managing Director for bulge-bracket investment banks on both sides of the Atlantic in research, strategy, asset allocation and product development roles, including at Deutsche Bank and Lehman Brothers.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)