We continue to believe that resources represents good value
Overall because of the bounce back in global economic growth combined with the limited supply of key commodities, exacerbated by supply chain difficulties
Added to this we are now in a stock picking market and the differences between the commodities producers are being magnified due to uncertainty.
Our concern about iron ore is that prices remaining sustainably high is a big incentive for renewed production, which we’re seeing out of Brazil. But because demand remains strong, the revenue line should weather the price impacts through increased volumes.
Volatility in iron ore prices
The iron ore price moves this year show that there is a tug-of-war between the increasing demand for steel from construction and manufacturing on the one hand; and on the other increasing environmental concerns from China in particular, as well as evidence of increasing supply from Brazil.
After a peak of US$167 per tonne CFR China (62% Fe Fines) in late December 2020, they regressed to around the US$140/t level in both February and midMarch before quickly rebounding on both occasions to US$165-168/t.The volatility reflects uncertainty on the direction of iron ore prices.
In China, steel production has been rising this year, due to expectations of increasing demand from construction and fast recovering manufacturing.
Compared with the same periods last year, crude steel production has climbed almost 7% in January to 90.2m tonnes and 2% in February to 83.0mt. The capacity utilisation of 163 blast furnaces surveyed in the first two months was 82%, according to consultancy Mysteel.
This evidence of growing steel production is backed up by average daily output in January to February, which was 2.97mt, up from 2.94mt in December and a daily average of 2.58mt in January and February 2020.
Total crude steel production was 1.053 billion tonnes in the whole of CY20 and while the growth momentum is there in steel production and hence iron ore demand, conditions are changing as the world gets serious about reducing emissions. The market intelligence unit for S&P Global, Platts is forecasting total China crude steel output for 2021 of 1,082mt, up only 2.8% or 29mt.
Pressure on carbon emissions and increasing supply
Carbon emissions from steel producers (about 15% of China’s emissions) and heavy pollution are on the radar of the environment ministries, in particular from China. Worries about steel output curbs have hurt benchmark iron ore futures on the Dalian Commodity Exchange in China, with 5% falls in deliveries for May against the prior month.
China has also clamped down on property sector financing, implying that China’s property steel demand could post its first decline in 6 years in 2021.
A slowing in the rate of steel demand growth and increased carbon emission and pollution pressures will tend to favour higher grade ore, with the risk to Australian producers that Brazil iron ore supply, which is recovering, will displace lower grade Australian ores.
Iron ore prices may remain firm for the rest of the year, but caution is warranted with regard to prices and potential increased competition from a production recovery in Brazil.
Conclusion: Revenues are the key
The concerns about pollution in China are not new. Fundamentally what over-rides this is the country’s ability to facilitate mass urbanisation – the migration from the country to the cities. In the past 5 years the RBA referred to this as the largest mass migration in human history.
Our concern about iron ore is that prices remaining sustainably high is a big incentive for renewed production, which we’re seeing out of Brazil. But because demand remains strong, the revenue line should weather the price impacts through increased volumes. We have seen this in the past. The likes of Rio Tinto, Fortescue and BHP are not simply exposed to the price of iron ore, but also to volume that they produce. Being among the lowest cost producers in the world gives them a significant competitive edge.