Iron ore has had a very good start in 2016 with prices rising 50%, making year-to-date best performing industrial commodity traded globally. The solid performance is due to the restocking cycle, before the spring construction season, coinciding with supply trouble in Australia and China. Other than seasonal reasons, there are other events that have impacted the sentiment.
Firstly, there was a considerable improvement in China's conditions with money supply growing 14% y/y in January 2016. Secondly, China's National People's Congress (NPC) session set additional dovish tone for policy, pointing towards larger budget deficit of 3% in 2016 and higher M2 growth. And lastly, the tie-up between FMG and Vale was announced to blend their iron ore.
Recently, there has also been an increase in steel and iron ore trade activity in China, with volumes and open interest in Dalian Exchange and Shanghai Futures Exchange surging. Since June 2015, steel and iron have moved in tandem, and the sharp rise in iron ore prices recently was consistent with the rise in domestic steel prices in the earlier trading session.
Meanwhile, FMG has clarified that the purpose of the joint venture with Vale is to bring the iron ore's quality to the benchmark rather than controlling production. This brings the attention back to fundamentals that continue to be weak.
China's crude steel consumption and production shrank sharply by 7% and 6% respectively in January and February. With increasing trade barriers, the rate of exports has moderate. Cash costs for iron ore majors continue to decline. At current prices, even the small producers will be encouraged to boost production.
"Overall, on rising supply and curtailed demand, we expect 149mt of iron ore surplus over the next two years, which we believe will bring spot iron ore prices closer to our estimate of USD41/t over the next few months", says HSBC.
