Iron Ore Jumps Most on Record as Market Goes Berserk
Comment of the Day

March 07 2016

Commentary by David Fuller

Iron Ore Jumps Most on Record as Market Goes Berserk

Here is the opening of this interesting article on another recovering commodity, from Bloomberg:

Iron ore soared the most ever after Chinese policy makers signaled their willingness to buttress economic growth, boosting the outlook for steel consumption in the top user and igniting speculation that some investors who’d bet against the market had been caught out.

Ore with 62 percent content delivered to Qingdao jumped 19 percent to $63.74 a dry metric ton, Metal Bulletin Ltd. data show. That’s the biggest gain in daily data going back to 2009 and the highest price since June. The surge was preceded in Asia by a rally in futures, with the most-active contract on Singapore Exchange Ltd. climbing 21 percent to $60 and prices on the Dalian Commodity Exchange rising by the daily limit.

“The iron ore and steel markets have gone berserk -- they’ve departed from fundamentals and are heavily driven by sentiment,” Zhao Chaoyue, an analyst at China Merchants Futures Co. in Shenzhen, said before the Metal Bulletin price was published. “Investors are expecting further monetary easing by the Chinese government to boost steel demand.”

Australia’s Fortescue Metals Group Ltd. jumped 24 percent in Sydney trading, where Rio Tinto Group and BHP Billiton Ltd. also climbed after futures prices jumped. Gains in London were muted. Rio, the second-biggest mining company, rebounded from an earlier decline in London trading and was up 2 percent by 1:04 p.m. local time, while BHP rose 1.1 percent.

U.S. producer Cliffs Natural Resources Inc. climbed 21 percent in pre-market trade by 9:11 a.m. in New York. Vale SA gained 6.7 percent in Brazil trading.

And:

Recent gains in iron ore probably won’t last, Goldman Sachs Group Inc. said in a report received on Monday, forecasting a drop back to $35 a ton in the final quarter. This year’s rally has been driven by rising steel prices in China, a reversal of the normal relationship seen between the raw material and the manufactured product, Goldman said.

‘Short-lived’

“We expect the current rally to be short-lived,” analysts Christian Lelong and Amber Cai said in the note, which was dated March 6, predicting further growth in iron ore supply in the quarters ahead. “The causality will revert sooner rather than later, and steel raw materials will one again drive steel prices rather than the other way around.”

David Fuller's view

One does not discount a Goldman Sachs forecast lightly, especially when they are participants in the market in question.  However, iron ore is doing what we are also seeing in most other industrial commodities.  The big miners geared up production several years ago because they were experiencing a post-2008 boom in prices on strong demand from China, which they mistakenly assumed would persist indefinitely.  Moreover, the efficiency of mining had improved dramatically, thanks to an unprecedented leap in mining technology. 

As the supply of iron ore and many other commodities soared, demand from China began to fall because Xi Jinping’s government was trying to manage the often difficult transition from a developing economy’s exports of refined metals, to a developed economy’s consumer-led growth.  Consequently, a severe bear market developed in industrial commodities, based primarily on oversupply, but also weaker demand from China and the rest of the world due to the slowdown in global GDP growth. 

This led to aggressive hedging by producers of metals and increasing bear trading by institutional speculators, many of whom have overstayed their welcome, judging from the steadier price action.  Meanwhile, supply has been waning since higher-cost producers found they could no longer make profits.  That is a recipe for explosive recoveries in the prices of exceptionally depressed metals, as short covering is followed increasingly by bargain hunting and stockpiling by users of metals. 

Veteran subscribers have seen this cycle before, as highly cyclical commodity prices have rebounded from depressed levels.  In my own experience this current, fledgling recovery is occurring from the most deeply oversold levels since at least 1974.  For this reason, I think Goldman Sachs forecast above that iron ore will drop back to $35 in the fourth quarter of this year is likely to be wide of the mark.  After all, supply will remain the key and big miners should now know enough to restrict supply somewhat when the current rally shows signs of losing momentum beyond small reactions and consolidations within the current recovery. 

We see a similar situation with the price of crude oil, although there are more exporters of petroleum and it faces greater competition from renewables.    

 

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