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Iron Ore: Soaring And Roaring

Commodities | Sep 14 2020

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China's economic growth strategy will be dominated by steel-intensive sectors and have led to a rebound in iron ore prices; Simandou's impact on iron ore prices in the medium to long term.

-Implications of the China-led steel demand rebound 
-The Simandou project: a potential flashpoint
-Iron ore stocks to consider

By Angelique Thakur

The art of bouncing back

The rebound in China’s steel demand, considerably faster than expected, has left Macquarie analysts surprised. But that's not all. Citi economists expect China to set a growth target of 5.5% in its 14th five-year plan. Admittedly, it is less than the 6.5% rate of growth aimed for by China in its 13th five-year plan. But, as Citi points out, indicates moderation as opposed to collapse of growth as was feared.

China has also indicated this growth will mostly be led by its domestic market. But what pleases Citi is the how of it. It looks like China will be focusing on developing its infrastructure. In particular, steel-intensive sectors like infrastructure, property, and automotive will be the key pillars for China’s economic growth.

This leads Citi analysts to expect steel end-use demand to increase by 1-2% (year on year) per annum during 2021-23 versus the -1% decline that was forecast earlier.

There's more. Macquarie points towards a steel demand recovery in the US, EU and Indian markets. According to Macquarie, the three catalysts for iron ore and steel include a continued recovery in the auto sector, stimulus by countries like China (focused on infrastructure development) and new proposed construction guidelines in China that could boost steel intensity in buildings (although there is no firm timeline for this).

So what does that mean for iron ore?

While Citi expects to see a moderate pullback in iron ore prices from the US$130/t price recorded recently (the highest in over five years), iron ore will likely be range-bound between US$100/t-US$120/t for the rest of 2020. This implies a higher average price forecast of US$100/t from the previously expected US$90/t.

Macquarie follows suit, taking into account positive leading indicators (along with buoyant iron ore prices) such as low port stocks and positive steel margins, and is bullish on iron-ore exposure.

How iron ore does in the future mostly rests on the Chinese demand for steel, asserts Citi.

Citi’s best-case scenario assumes steel demand growing at an annual rate of 5% in 2020-21, which will see its iron ore price forecast surge to US$110/t in 2021. The analysts’ bear case assumes steel demand falling -1% year on year in 2020 and beyond. This will prompt iron ore prices to drop below US$80/t by 2020 end and further to US$60/t by the end of 2021, forecasts Citi.

JP Morgan expects 2021 iron ore price to touch US$105/t from a US$100/t forecast earlier. JP Morgan also envisages iron ore prices will remain elevated until Simandou comes into the picture, which is expected to be in about five years. This brings us to a potential threat – the Simandou project –  which may be the next battleground in the war for iron ore market share.

The next battle

Guinea’s (West Africa) Simandou project could be a game-changer, suggests a report by Morgan Stanley. The broker contends unlocking the world’s largest high-grade iron ore deposit may unsettle the “truce” in the iron ore market. It could result in the major players abandoning their present "value-over-volume" stance and trigger the next “market share battle”. 

If this plays out as Morgan Stanley predicts, it may lead to adding another 200mtpa of low-cost supply to the market. And this is excluding the 110mpta expected from Simandou North. This will hit the price of iron ore with Morgan Stanley forecasting an impact of -US$7-12/t in the long term.

The fact that the project has a high investment cost may not be enough to deter its development, feels Morgan Stanley, seeing as China has more important things on its mind than mere project economics (namely a reduction in dependency on Australia’s ore).

Citi analysts also reckon the rising availability of Chinese steel scrap may pose a danger. On the whole, however, Citi feels steel scrap recycling and processing activities will probably struggle to ramp up fast enough to lead to a collapse in the prices.

Post-2023, Morgan Stanley expects China’s steel output to decline and no sufficient ex-China growth to offset this. Even without Simandou, the long term iron ore price is expected to be on the lower side. This is in sync with Citi analysts who think iron ore prices will fall back to around US$60/t in the next decade.

Which stocks look good?

Citi likes pure-play iron ore names like Fortescue Metals Group ((FMG)) and Mount Gibson Iron ((MGX)). Rio Tinto ((RIO)) is expected to give the highest absolute increase in earnings given the size of its iron ore footprint. Citi rates both Rio and Mount Gibson as Buy and highlights Rio as its preferred pick given the opportunity for higher dividends over the next three years.

Macquarie likes Fortescue Metals Group in large caps and Mineral Resources ((MIN)) in smaller caps. BHP Group ((BHP)) is another preferred pick. JP Morgan also likes Fortescue Metals Group and upgrades its rating to Overweight. JP Morgan notes both BHP and Rio Tinto also offer compelling valuation metrics.

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