Iron ore's bull run still has legs

Tom RichardsonMarkets reporter and commentator

May 20, 2020 – 5.52pm

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The iron ore price could race past $US100 a tonne over the short term as Chinese stockpiles run low and supply out of Brazil falls at a time of peak demand, according to one of the market's leading resources analysts.

Glyn Lawcock says China's iron ore inventory is under pressure as seasonal demand for steel rises. Photo: Rob Homer

On Wednesday, benchmark iron ore prices hit $US98.36 a tonne, up 1.6 per cent, with rising demand for the steel-making ingredient powering Fortescue Metals shares to a record high of $13.98.

UBS's global head of mining, Glyn Lawcock, said China's strong rebound in post-lockdown activity at a time of low iron ore port inventories and seasonal demand meant the price can advance.

"Port inventory in China is back to 110 million tonnes," Mr Lawcock said. "In mid-2018 they had 160 million tonnes at the ports, so they're down by a third, and remember back in 2018 Chinese steel production was about 930 million tonnes. Today it's 966 million tonnes and climbing.

"We bottomed out at 110 million tonnes of port inventory last year and the iron ore price topped out at about $US125. We're not at $US125 today because the world's not growing as strongly as last year for obvious reasons."

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Chinese steel production is now at a run rate of 966 million tonnes a year in 2020, according to Mr Lawcock, despite the impact of COVID-19, versus 996 million tonnes produced in 2019.

"But not every month averaged a 996 million run rate [in 2019]. You have weaker months over winter and summer when construction activity ebbs. Year to date the run rate is actually up 1 per cent."

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However, a tight market in the middle of China's biggest building periods of March through June followed by September through November were bullish for iron ore, he argued.

"There's nothing to suggest Chinese demand is going to wane in the next four weeks since we're in the peak of the construction period.

"We go into a slightly sluggish period in July and August as they go into their wet season, and you can't pour concrete in hot weather. So temperature and rain impact activity levels."

China has recently absorbed boats turned away from virus-hit Europe, Japan, South Korea and Taiwan, which account for about 20 per cent of global demand.

In these regions the return of idled steel plants and automotive manufacturers this week means competition for the steel-making ingredient should heat up again.

Brazil toll

Aside from robust Chinese demand, falling supply has also inflated iron ore prices since March.

"Twenty three per cent of global supply is from Brazil and Brazilian exports are 12 per cent down year to date," Mr Lawcock said.

"Everyone's asking the question, what's wrong in Brazil?

— Glyn Lawcock, UBS's global head of mining

"Last year Brazil exported around 350 million tonnes. That's 6.5 million tonnes a week. They've only had one week this year where they shipped above 6 million tonnes. The last three weeks they've shipped less than 4.5 million tonnes a week.

"Everyone's asking the question, what's wrong in Brazil? The first quarter you can blame weather, the wet season, but now weather is truly behind us as an excuse.

"Brazil is now number four globally in terms of COVID cases. It's really escalated. So I believe absenteeism in the workplace is hurting production.

"You can't move dirt working from home."

The UBS analyst argued that uncertainty over the duration of Brazil's lost production was yet more evidence that the market would tighten over the short term.

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"Chinese demand is pretty strong and port stocks are drawing down every week, which tells you there's a deficit in the market. It looks like they'll continue to draw down because Brazil is six weeks away in sailing terms and hasn't yet recovered from COVID-19.

"No one's shipping more volume. Everyone's shipping as fast as they can. It's not like BHP, Rio and Fortescue are saying, 'Let's hold back tonnes.' They're shipping every tonne they can.

"Australia's exports are up year to date. We've had a much better start to the year than last year when we were heavily impacted by weather the first quarter."

UBS rates Fortescue shares a "buy" on expectations that it will deliver strong free cashflow and dividends on robust iron ore prices. The broker also favours BHP over Rio Tinto because of its additional exposure to a potential rebound in oil prices as oil markets also enjoy a price-lifting rebalance.