Iron ore has rallied 250% from March 2020 lows of around $84 per ton to almost $212 a ton a year later. Now, it has fallen about 25% in the last few weeks, and the market is wondering whether this is it for the shiny metal?
China was the first nation last year to suffer a demand collapse amid COVID-19 and went on a growth rampage on infrastructure and construction to help boost its economy out of recession. It went against what it had been trying to achieve over the past few years: deleveraging. The boom of 2004 onward was fuelled by infrastructure and urbanization and since then, China vowed to delever to keep its credit in check and move to a more consumer-oriented model that that of infrastructure. But post COVID, it had no choice but to change gears, as infrastructure spending is one of the fastest way for any economy to stimulate the economy, and fast.
China buys about 70% of total seaborne iron ore to produce roughly half of the world's steel output. It has been soaking up as much iron ore possible to produce as much steel to satiate its demand. Iron ore imports are up 6.7% in the first four months of the year to 381.98 million tons, according to official data. Steel output hit a record in April, reaching 97.85 million tons, up 4.1% from March. That took production for the first four months of the year to 374.56 million, up 16% on the same period in 2020. But China has another problem on its hands, this incredible steel production surge is putting pressure on Beijing's annual target of production being below 1.065 billion produced in 2020, as they need to keep their emissions targets in check given their promise to limit pollution.
Rising demand from China has been with rising demand from other importers, too. Japan, Asia's second-biggest buyer of iron ore, imported 8.99 million tons in April, according to Refinitiv, the highest monthly total since September 2019. South Korea, the third-biggest importer in Asia, brought in 6.79 million tons in April. Meanwhile Europe's seaborne imports rose to 8.71 million tons in April, the highest since October last year. So, this demand surge is not just a Chinese phenomenon. The entire world is expanding their infrastructure as they all need to boost their fiscal spending plans. There has been a double-whammy effect, though. Supply has fallen short during this time, given supply constraints in Brazil and Australia. Australia is producing below the 80 million tons per month potential and Brazil is well below its 35 million tons target, too. Together these factors are causing a sharp rise together with investors chasing the reflation narrative.
Over the last 6 months China has been trying to take its credit growth down. This can be seen in lower rate of change in their PMIs and economic data, but it takes a few months before that slowdown impacts prices as such. An anticipated slowdown in steel demand in China to ~ 3% in 2021 from 10% in the second half of 2020, and improving exports should remove these tailwinds and help prices to normalize.
The reflation narrative has helped some commodities move above and beyond their fair value, but commodities are all a timing game. If one sees a massive demand surge in a short period of time, that can take prices higher by a mile. The supply is there, it just takes time to show up, unless it is something like copper, which needs a lot more investment to meet new rising alternative sources of demand from electric vehicles, for example, as well.
We know China is not eager to enable investors and traders to get ahead of them front running their demand. Officials are now focused on curbing any speculation to cool off prices. This is coming at a time when the Fed is debating whether to cool off its own quantitative easing program as maybe, just maybe, inflation may not be "transitory" after all.