Market steels for fall on China glut

A SURFEIT of steel products in China's factories is set to crimp demand for Australia's iron ore exports, and analysts say it will take months to fix the problem.

By InvestSMART · 31 Aug 2012

By InvestSMART ·
31 Aug 2012

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A SURFEIT of steel products in China's factories is set to crimp demand for Australia's iron ore exports, and analysts say it will take months to fix the problem.

Australian iron ore stocks were smashed yesterday after the price of the metal fell $US4 a tonne overnight to near three-year lows of $US90.30. In the past month alone the global price of iron ore has lost 23 per cent.

Yesterday the local market lost 1 per cent, with big falls for iron ore majors BHP Billiton and Rio Tinto, which were off 2.4 per cent and 3.8 per cent respectively.

Analysts said Chinese steel production was increasing in the first six months of this year while construction was slowing down.

"This isn't a story that's going to disappear overnight. It is going to take months and months for Chinese inventories to clear," Westpac chief currency strategist Robert Rennie said.

Official steel prices are being cut and some Chinese steel plants are closing their doors. Zinc production has been cut back significantly and coal production is dropping.

In the three months to July, China's steel production was running at record levels. It produced 182 million tonnes of steel in that time. In the first six months of the year, it produced 687 million tonnes: a record.

UBS's long-term outlook for iron ore is $US70 to $US80, with the fall being driven by extra supply from new projects rather than weak demand from China.

"I don't think anyone expected iron ore prices to drop as quickly as they have and that's from the demand side as we're seeing a slowing in China and opportunistic de-stocking," said UBS Perth office head Tim Day. "On the supply side, once it slides below $US120 you start to see a lot of the marginal producers dropping out."

As demand for iron ore falls, it's bad news for Australia. Last year iron ore accounted for 20 per cent of Australia's exports.

Prominent hedge fund manager Jim Chanos is betting on iron ore producers struggling as Chinese demand slows, singling out Fortescue Metals, saying it's a "value trap" and short-selling the stock, betting that it will fall. Fortescue, which argues that iron ore prices will rise again, fell 1.6 per cent yesterday. With RANIA SPOONER

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Frequently Asked Questions about this Article…

What is driving the recent iron ore price fall and China steel glut?

The article says a surfeit of steel products in Chinese factories has flooded inventories, forcing official steel price cuts and some plant closures. Chinese steel production ran at record levels (182 million tonnes in the three months to July and 687 million tonnes in the first six months), while construction slowed and opportunistic de-stocking took place. That combination has driven iron ore prices down sharply.

How big has the drop in iron ore prices been and how has the Australian market reacted?

Iron ore fell about US$4 overnight to near three‑year lows at roughly US$90.30, and the global price lost around 23% in the past month. Locally the market fell about 1% yesterday, with major miners BHP Billiton and Rio Tinto down about 2.4% and 3.8% respectively, and Fortescue Metals down about 1.6%.

How long will it take for Chinese steel inventories to clear and what do analysts expect?

Westpac’s chief currency strategist Robert Rennie said this isn’t a problem that will disappear overnight — it will take months for Chinese inventories to clear. UBS analysts also note falling prices and point to supply factors from new projects affecting longer‑term levels.

What is UBS’s long‑term forecast for iron ore prices and what's behind it?

UBS’s long‑term outlook cited in the article is US$70–US$80 per tonne. UBS says the expected fall is being driven more by extra supply from new projects than solely by weak Chinese demand.

What price level could force marginal iron ore producers out of the market?

According to UBS Perth head Tim Day quoted in the article, once iron ore prices slide below about US$120 per tonne you start to see a lot of the marginal producers drop out.

What does the iron ore slowdown mean for Australia’s economy?

The article notes it’s bad news for Australia because iron ore accounted for about 20% of Australia’s exports last year, so a sustained drop in demand or prices could have significant export and economic implications.

Are investors or hedge funds taking positions on Australian iron ore stocks?

Yes. Prominent hedge fund manager Jim Chanos is short‑selling Fortescue Metals and described it as a 'value trap', betting the stock will fall as Chinese demand slows. Fortescue, meanwhile, maintains iron ore prices will rise again.

Are other commodities or sectors being affected by China’s steel situation?

The article reports official steel price cuts and some plant closures in China, with knock‑on effects including significant cutbacks in zinc production and a drop in coal production.