Will the iron spike save struggling miners?

Have the doomsayers gone too early on iron ore in light of the recent price recovery and renewed market confidence. Or is the commodity merely experiencing a stimulus-inspired bounce?

If the recent bounce in the iron ore price turns out to be a medium-term thing then its near-$US120 price is good news for all Australian miners and especially all those below BHP Billiton and Rio Tinto.

The price of iron ore spiked for the second straight session on Tuesday night and has now lifted 12 per cent since the end of China's Golden Week holiday, finishing at $US117.20.

Fortescue for one will be breathing a sigh of relief given that the $US120 per tonne price is often cited as the magic number at which all its recent problems around debt covenants and strife with ratings agencies will begin to dissolve.

For the many junior miners who started projects when the price was going up, and which are still under construction, a $US120 significantly improves their prospects. For example, analysts generally see it as the price at which those projects in Western Australia’s mid-west, like Jack Hills and others revolving around the stalled Oakajee Port and Rail project, will begin to look more attractive to potential financiers, which will be essential to their survival.

The question is whether the jump above $US117 is a lasting adjustment or just an overcorrection after the sharp drop to below $US90 in September?

Fortescue’s chairman Andrew Forrest certainly seems to think it’s the former. The miner yesterday released its annual report in which Forrest said he expected the price to bounce back amid strong demand from its Asian customers.

"While we endured hardships during the first few months of the 2013 financial year, we remain confident iron ore prices will firm and we will emerge in an even stronger position in the months and years ahead," he said.

"We continue to see strong demand from our customers, new and old, as we sign up commitments for additional tonnes of iron ore to be met by our expansion."

Goldman Sachs speculated in a note that the spike in price may be the beginning of a fourth-quarter buying spree by the Chinese steel mills as the traders and steel makers who drove prices down 36 per cent in the last two months begin buying again.

Given that we know China put its economic brakes on a little too hard in trying to deflate its growing property bubble, it is possible that its stimulus measures will lead to an adjustment as iron ore stockpiles begin to fall and steel production increases.

There are also a couple of short-term factors that may have contributed to the rally in the price: China announcing another mini injection of stimulus, 265 billion yuan ($41.2 billion), overnight and Anglo American's South African unit, Kumba, is experiencing strikes at its Sishen mine which is costing the company 120,000 tonnes in production per day. Kumba is among the top ten iron ore miners in the world and says it only expects to be able to meet its supply contracts until mid-October with loading operations also affected by the strike.

Furthermore, as Markets Spectator’s Ben Potter pointed out that (MARKETS SPECTATOR: Soaring ore, October 10) sentiment towards Chinese stocks is starting to improve as well, with the Shanghai Composite now up 5.8 per cent since the low 10 days ago.

While China has a large degree of control over the iron ore price from the demand side, Australian miners are not completely helpless. Forrest mentioned Fortescue's decision to slow down its expansion in production capacity to its target 155 million tonnes per annum. This move is in the same vein as BHP Billiton’s decision to shelve its Port Hedland Outer Harbour and Olympic dam projects.

These moves have generally been portrayed in a negative light, and yes they have come at the cost of jobs and economic growth for some regions of Australia, but they can also be seen as dynamic response to scale back supply and stop the bottom falling out of the price.

There seems to be two parallel and contradictory narratives developing around the prospects of Australia’s key iron ore exports, which shows no one has much of a clue about what’s going on.

Of course all iron ore forecasts are strongly linked to Chinese economic growth and we got a bit of a mixed bag from the IMF last night. On the one hand, it said the outlook for global growth for the remainder of this year was relatively glum, with predictions for China’s economy to grow at around 7.8 per cent. But then next year easing measures will start to kick in lifting its rate of growth to 8.2 per cent.

So while no one seems game to predict the outlook for iron ore with any certainty the below graph from Westpac Economic's Phat Dragon shows what the price has done since it peaked in February 2011.



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