how low can io go

posted this afternoon on AFR website. sorry several charts did not copy across

RICHARD LIE
Stone me if you must, but I reckon the alarmist headlines about iron ore are a little over done. We’re currently trading at a little under $US100 a tonne, a long way above the lows of $US60 a tonne in 2009. Also, this is a thinly traded and volatile commodity, one affected by all kinds of changeable micro-economic as well as macro forces. Spikes of 5 per cent-10 per cent are commonplace.

It’s an emotionally charged subject for Australians, given that these dirty brown rocks helped deliver us prosperity that is the envy of the world. But let’s be clear about this. China has not packed up her bags and left the building. Feelings aside, what can we say with certainty about iron ore?

THE FUNDAMENTAL BACKDROP:
The macro story: Growth in demand for iron ore has been falling while supply has started increasing at a greater rate - Chinese steel mills have been demanding less ore, while the Australian miners have been supplying more. This is most definitely a short-term headwind for the price. And yet demand is not drying up either. Far from it, Chinese demand for foreign iron ore is still growing year-on-year on an absolute basis - steel production is expected to peak around 2026.

The micro story: The catalyst for the recent fall in the iron ore price was an exogenous shock. Chinese State-controlled banks changed their loan requirements to the steel mills - effectively requiring 20 per cent repayments on outstanding debts – in a push to make the industry more efficient, and to drive out less productive and high polluting operators.

If iron ore could talk, it would probably say: “Reports of my death are greatly exaggerated.”

THE TECHNICAL PICTURE FOR IRON ORE:
Since 2011, the trend has been down, and that downtrend should be respected. The next level of support is the 2012 low, around $US85.00 a tonne. That should stop the fall, at least temporarily.

It will be interesting to see how price responds right here, below $US100 a tonne. Round numbers can be strong psychological inflection points. Although iron ore broke that level marginally early this week, if it were to recapture it in a short period of time (days), that short-term strength could turn this $US100 level into support. If price consolidates below $US100, it will act as resistance, and sub-$US100 could become ‘the new norm’.

In the months (and possibly years) ahead, I expect $US100 to be an important ‘line in the sand’ - the demarcation line between bulls and bears. This level should be monitored carefully of the next few days as well.





Here’s what ANZ’s head of commodity strategy Mark Pervan has to say:

“Heightened speculative activity in Chinese steel prices has accentuated the iron ore price declines and while sentiment remains weak, we can’t discount further price falls. We think it’s too early to revise our price forecasts, particularly in light of the volatile nature of iron ore trading, and because of an approaching expected lift in seasonal demand.”

Pervan believes that once this initial one-off selling pressure, or ‘liquidation phase’, is done, the impetus for further losses will ease. Another positive driver for iron ore prices is the seasonal tendency for stockpiles to fall in the months ahead - see the chart below.





Richard Lie is the founder of the hedge fund Crusader Capital Management, and the stock advisory service www.stockradar.com.au which is currently offering free trials.