- NAB sees limited short-term upside for iron ore
- Coal prices also forecast to ease through 2012
- Commodity prices in general tipped to decline through 2012
By Chris Shaw
Following falls to what National Australia Bank saw as oversold levels in October, bulk commodity prices have partially recovered in recent weeks. The magnitude of the change in prices has been significant, NAB noting from a September peak the iron ore price declined by more than 35% to US$117 per tonne before subsequently rising by 25% over the following two weeks.
Prices have not fully bounced back to previous levels, something NAB suggests is a reflection of the market adjusting to an apparent slowdown in global demand and the increasingly uncertain global outlook.
In NAB's view this uncertain outlook means there is limited short-term upside for iron ore prices. Not helping is the lack of a clear growth outlook in China, as while activity indicators for October suggested a soft landing the outlook implied by forward indicators is far less certain.
Global steel production rose slightly in October, an uptick NAB notes followed four consecutive months of declines. Output remains well below the levels seen earlier this year. China remains the key, given steel production in that country is very important to bulk commodity markets given a heavy reliance on blast furnaces.
In NAB's view, the fall in Chinese steel production reflects a softening in the construction sector and high input costs squeezing profit margins. This margin pressure has eased slightly in recent weeks given the sharp decline in prices in October.
For some time NAB has taken the view ongoing strong demand from China would offset expected sluggish growth in Europe and the US, but market sentiment now appears less confident in such an outcome.
Longer-term fundamentals remain relatively positive, as industrial production and retail sales continue to grow at a reasonable pace in NAB's view. This suggests the recent slowing in fixed asset growth in China is not a major cause for concern at the current time.
As evidence of this NAB notes despite a series of policy tightening measures the level of residential investment in China has held up reasonably well. While the volume and value of transactions has been in decline in recent weeks, the ratio of residential building under construction to completions remains quite high. This implies the current rate of completions could last for a further five years.
Tight credit controls are causing some problems, as firms are increasingly finding it tough to obtain credit for projects. This could have implications for commodity markets in NAB's view, in part because it disrupts the ability of commodity importers to make payments on contracts but also because it threatens the viability of some investment projects.
These concerns have seen authorities start to take action to address these liquidity constraints, including the lowering of some reserve requirements on the back of indications inflation concerns may be easing.
For iron ore, a look through recent volatility shows despite the price falls last month apparent consumption in China remains at record highs. Most of the apparent consumption growth has come from domestic production increases, but falling ore grades and rising costs could mean mills will need to tap further into seaborne markets for supplies.
Lower seaborne prices have increased the incentive to purchase imported iron ore but with much of the Chinese restocking having already taken place, buyers appear content to sit on the sidelines at present. This leads NAB to suggest there will be little upward momentum in prices in coming weeks.
The recent drop in prices has sparked reports of Chinese buyers reneging on contracts to achieve more favourable prices, NAB noting Vale reportedly gave in to some such demands. BHP Billiton ((BHP)) and Rio Tinto (RIO) are expected to follow suit to some extent in an effort to maintain respective market shares.
As a result NAB expects December contract prices should be lower than reported, with average prices likely to be around the US$150 per tonne level. Tight supplies should support prices around that level for the medium-term, though NAB sees prices easing to around US$130 per tonne by the middle of 2013 as new capacity comes on-stream.
Prices in the thermal coal market also eased in October and now stand around 18% below the peak for the year. Weaker demand from China and Japan was the main driver of the declines but again NAB sees underlying fundamentals as relatively supportive.
While coking coal prices have also eased the market is also being impacted by the push by miners to short-term contracts. This drive, and weakness in both steel and iron ore markets, suggests further short-term downside for prices in NAB's view. Support is likely to emerge around Q1 contract price levels.
In terms of forecasts for the bulks, NAB expects quarterly iron ore prices of US$168 per tonne for the December quarter of this year before a fall to US$140 per tonne in the March quarter of 2012. Prices should ease further to US$135 per tonne for the remaining three quarters of next year.
Hard coking coal is forecast to average US$285 per tonne in the current quarter before a fall to US$235 per tonne in the March quarter of next year. Prices in the June and September quarters of 2012 are forecast to average US$245 per tonne, before a further fall to US$225 per tonne for the final quarter of next year.
The outlook for thermal coal is also for a weakening in prices, NAB expecting averages of US$130 per tonne for the December 2011 and March 2012 quarters, then an average of US$112 per tonne for the June through December quarters of next year.
Semi-soft coking coal prices should be a little more volatile, NAB expecting an average of US$215 per tonne this quarter before a fall to US$180 per tonne in the March quarter next year. June and September quarter prices should lift a little to US$185 per tonne, before a further easing to US$170 per tonne in the final quarter of 2012.
Elsewhere in commodity markets NAB suggests the same uncertainties over the European debt crisis and the global growth outlook have also pushed prices lower, while market volatility has risen in recent weeks.
The uncertain growth outlook can be seen in the fact NAB has lowered its global growth forecasts in recent months, to levels around trend rates. As much of the growth will come from emerging economies this should help support commodity prices at levels above long-run averages.
The concern is the threat of a prolonged slowdown in Europe and other major trading partners could have a significant impact on emerging market production in NAB's view, something that would have a corresponding impact on commodity demand.
In terms of specific markets, NAB notes while geopolitical issues and near-term supply constraints are supportive, crude oil prices have declined in recent sessions. This reflects weaker demand given the global growth concerns.
Base metals have continued to suffer from a risk-off attitude on the part of investors, so keeping prices relatively low compared to levels of a few months ago. Gold also suffered in October and NAB attributes much of this to the recent strength in the US dollar. Gold prices should continue to be influenced by the current volatility in financial markets in NAB's view.
In coming weeks NAB expects markets will remain focused on Europe's debt issues and the capacity of emerging economies to weather the current global headwinds. Even allowing for this, prices are expected to remain at relatively high levels.
The NAB Non-Rural Commodity Price Index is forecast to rise by around 24% through the year to the end of December, before an expected fall of 16% in 2012 in US dollar terms. NAB's forecast is for the Australian dollar to be above parity against the US dollar at the end of 2012 and to gradually depreciate through 2013. This means the Index in Australian dollar prices is forecast to rise by 20% for the year to the end of this December, before a fall of 16% through 2012.
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