The iron ore slump. Where to for prices next?

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The collapse in iron ore prices was a bit of a shock for the Australian economy, highlighting our recently developed dependence on China and the mining sector.

Indeed, iron ore is now Australia’s largest single export, accounting for 20% of export revenues. furthermore, 70% of our offshore sales go to China.

Along with higher coal prices, the huge price rise in iron ore over the past decade (from around US$30 per tonne to about US$100 per tonne at present) largely accounts for the surge in export prices in recent years. As a result, exports boosted national incomes and Federal Government budget revenues. Importantly, these prices placed a rocket under mining sector share prices.

But since its peak at around US$190 a tonne early last year, the spot price of iron ore on world markets has virtually halved – dropping as low as US$86 recently. The biggest surprise has been the speed of the drop: iron ore prices are down by a third in the past few months alone. The fact the Aussie dollar has remained high throughout all this – due to safe haven buying of government bonds by foreign central banks – hasn’t help insulate mining profits from the global price slump.

Made in China

The iron ore price has since recovered to just over US$100 a tonne, though the outlook remains clouded by a sluggish Chinese economy (by its standards). China’s steel sector has been hit by both weaker manufacturing exports due to the global growth slowdown, and a much-needed cooling in its overheated housing construction sector.

Making matters worse, as a good employer, China’s steel makers have long been overly subsidised by regional governments, leaving the sector inflexible and prone to overcapacity. Indeed, despite the slowdown in Chinese demand for steel products, local producers have been tardy in cutting back production, resulting in rising steel stock piles. The end result has been a collapse in China steel prices, with a knock-on effect on the major steel making raw material – iron-ore.


Where to from here? The good news is that the global iron industry is considered to have a natural price floor at around $US120 – this is the level at which China iron mines are rendered uneconomic, requiring the country to import more (largely from Australia). So partly compensating miners for their lower prices should be increases in demand from China.

Note: it’s also likely that once China gets passed its (drawn out) political leadership transition by year-end, policy should re-focus on measures to boost economic growth again. Only recently, for example, a US$160 billion package of infrastructure projects was announced. Though many of these projects have already been in the development pipeline, their completion will take many years.

Most importantly, over the longer-term, if the Chinese can keep growing per capita incomes by around 6 to 7% per year – to a still relatively low US$20,000 by 2025 – its economy will triple in size.

Even with a somewhat reduced steel intensity, this growth should still be strong enough to underpin strong growth in steel production and iron ore demand. The bullish forecasts of our mining sector could still be realised if China’s steel intensity over the coming decade or so remains as high as that of Japan and Korea at a similar relatively early stage of development.

Of course, that iron ore prices are falling, however, should be no surprise given prices reached such stratospheric heights last year. Even without the slowdown in the Chinese economy, prices are also responding to the inevitable iron ore supply response.

Australia’s official resource sector forecaster – the Bureau of Resources and Energy Economics (BREE) – expects Australian iron ore export volumes to increase by around 10% in both 2012 and 2013.

Most analysts concede iron prices reached their peak last year, though most still feel prices will remain above historical norms over the next few years at least. BREE’s latest forecasts anticipates contract prices to average US$126 this year, falling to an average of US$101 in 2013.

Mining profits

Despite weaker prices, the pickup in export volumes – together with a potentially low Aussie dollar overtime in line with weaker commodity prices and a further lowering in local interest rates – should provide some support to mining sector profits. According to Thomson Reuters’ latest estimates, earnings for companies in the MSCI metals and mining index will drop 8% this financial year before rising by 22% in 2013-14.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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