Why iron ore prices will rise

Here's why Iron Ore contract prices will rise 20%

The market should work out the whole iron ore import price game being played by the Chinese is just a game. It's the Government simply trying to pull the smaller steelmakers into line, and let the big guys like Baosteel negotiate for them as a group, rather than have 40 different mills all signing agreements on their own and sending spot prices to the moon. The Chinese have played games with so many commodities in the past 12 months, copper, nickel, manganese, soy beans etc. This is just another, and look how spectacularly their copper price manipulation efforts backfired.

Here are 7 simple reasons to keep buying the 2 major iron ore players

1) Speaking last week to iron ore companies in Perth they reminded us of one simple fact. You cannot turn off a blast furnace. If you do, it takes you over 6 months to re-start even a mid-sized blast furnace and get it working up to nameplate capacity again. Are you really of the belief that hundreds of Chinese steel mills are going to produce ZERO over the next 6 to 12 months or more? Of course they won't.

2) The Chinese rely on imported iron ore for around 60% of their iron ore needs, with the rest supplied by lower grade Chinese domestic ore. Chinese iron ore imports were up 37% in February to 24.9m tonnes. For the first two months of 2006 they are up 31% to 51mt.There is no way they will be able to feed their own mills within a few months with domestic stockpiles estimated at only 2 months, and at the same time watch rivals like the Koreans, Indians, and Japanese lock in the supply. Spot prices are 35% above current contract prices.

3) The Indian Government is talking of banning the export of high-grade iron ore. The Indians know they need it for themselves. After Australia (41% of the exports into China), India is the 2nd largest exporter of iron ore to China (25%), and clearly that is going down with the Brazilians in 3rd place down at 14%.

4) The Premier of China, Wen Jiabao, is coming to Australia in April. He ain't just coming to see the Opera House!

5) The iron ore market has never been tighter. Demand growth for iron ore continues unabated. The supply side continues to be constrained. HRC steel prices continue to rise globally as demand improves, and excess inventory is worked through. Strong steel prices show demand for the final product is strong.

6) The major iron ore producers will not give up their pricing power after just one year in the sun. The management and boards of the major players know this is a defining moment for industry pricing power. If they can prove to a sceptical investor base they truly have pricing power, which we think they do, you will see positive P/E ramifications.

7) There have been very almost no new large-scale discoveries of iron ore that can be brought on quickly. Almost all the new projects are in Western Australia and are start up greenfields operations from mining juniors which are at least 2-3 years away from production, assuming the infrastructure gets built on time, which is a big call in this era of cost and time blowouts. Production growth in high grade iron ore will come from the incumbent majors over the next two years, and that won't even meet global demand growth.

We continue to recommend accumulating both BHP and RIO shares through this "uncertainty" period, particularly as this market clearly "waits to be told". It will be told before the Chinese Premier visits here that iron ore contract prices are up another 20% for JFY2006.