Iron ore to recover with global growth

Tags: Commodities
Iron ore to recover  with global growth
Iron ore prices are currently trending close to $120 a tonne, which is up 33 per cent from the near-term lows seen during August-September, although still down 14 per cent from the beginning of the year. $120 was a strong support for iron ore prices since the beginning of 2010 till August-September. This is primarily because globally marginal cost of production for iron ore resides at these levels, particularly in China, which accounts for 60 per cent of the global demand. Of the rest 40 per cent, as much as 20 per cent is accounted for by North America, Japan and Europe, where the macro-economic outlook is still quite hazy. The rest of the demand is fragmented across various economies.

The demand for steel and its key raw material iron ore has seen a sharp deterioration on the back of weakness in global growth and slowdown in Chinese fixed asset capital formation. This resulted in iron ore prices falling even below the marginal cost of production for a brief period during August-September, making many mines unviable in China. We believe iron ore prices will remain supportive in the near to medium term with some expected revival in demand, although we do not expect the prices to see any sharp run-up as the global economy is expected to continue muddling through the ongoing crisis.

China remains a key determinant of iron ore demand and price trends. Hence the movement in the Chinese inventory will give an indication as to how the prices move. The Chinese steel inventory has fallen by almost 30 per cent and concurrently there has been a drop in the iron ore inventory during the same period. This is on the back of significant slowdown seen in China, where PMI numbers have dropped to multi-year lows. We believe the new leadership in China may try to spur economic growth and revive some investment demand, which could drive demand for steel and lead to replenishment of iron ore inventories.

According to the World Steel Association, steel demand is expected to recover in China in 2013, growing by almost 3.1 per cent compared with 2.5 per cent expected growth in 2012, and the near-term supply dynamics for iron ore remain tight with some of the supplies moving out of the system in India.

To some extent, the recent surge in iron ore prices could be attributed to this increase in anticipated demand. We remain supportive about iron ore prices in the near term, thanks to the high marginal cost of production in China, a partial recovery in demand and near-term tightness in supplies. Hence, iron ore prices may mean reverting closer to $130-135 levels over the next one year. However, since the global economy is expected to see only a protracted recovery, the fixed asset investment in China is likely to peak out at 70 per cent of GDP and incremental low-cost supplies come in after 2014, we could see some price pressure towards 2014. Till then, we see scope for iron ore prices to be on the path of recovery. zz

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