Talk about changing direction with the last sentence
It’s taken a while for iron-ore prices to react, but spot iron ore has fallen by around 30% in the past month, according to reports out last week.
Analysts said that iron ore has lost ground as worries about China’s economy saw Chinese steel mills reportedly hold back from making purchases, and as supply increased.
“Iron-ore prices have finally capitulated, as fears of weaker demand have driven away the marginal buyer,” said Citigroup analyst Daniel Hynes.
“Weakening sentiment across the steel supply chain in China has been prompting a depletion of stocks at mills and thus a cut in iron-ore buying in recent weeks,” he added.
Reports of tighter credit conditions and record supply from Australia and Brazil have added to downward pressure on pricing for iron ore, according to RBC Capital Markets strategists.
Australia and Brazil supply around 75% of the seaborne global iron-ore market, and China imports around 60% of total global seaborne iron ore, the strategists said.
With such a large share of the global market, iron-ore exports have become an important part of the Australian economy, accounting for around 14% of Australia’s total exports and 2.5% of Australia’s nominal gross domestic product, according to TD Securities research.
Exports of iron ore and coal, which together make up around 40% of the country’s total merchandise exports, have helped to boost Australia’s terms of trade — the ratio of export prices to import prices — to highs not seen for more than a century.
That also means that a drop off in iron-ore and/or coal exports could result in a downswing to Australia’s terms of trade.
First-quarter benchmark iron-ore prices are set to reflect recent prices changes, the RBC strategists said, and are on track to fall 10% from the fourth quarter. Benchmark prices are an average of quarterly spot prices.
The strategists said that they expect a drop in prices of this magnitude would translate into a 3% fall in Australia’s terms of trade in the first quarter of 2012 and a 6.5% drop for the year.
“Further falls through 2013 and beyond are likely as supply begins to come on line,” they said, while adding that the terms of trade would still be around 70% above average.
The risks for their view on Australia’s terms of trade “appear skewed to the downside” they said. Key factors to watch include the iron-ore buyers’ strike in China continuing into the new year, and Chinese growth falling to sub-par levels of 8% or below.
A drop in terms of trade could work its way through to the Australian economy, for a start by lessening available income.
“By our calculation, national income growth has outstripped gross domestic product by 1%, on average, per year over the last decade due solely to the terms-of-trade shock,” the RBC strategists said.
Given the importance of iron-ore exports to the Australian economy, a continued sharp drop in iron-ore prices would likely be relevant for Australian monetary policy.
Citigroup strategist Paul Brennan said that “lower commodity prices are setting the scene for lower inflation. … This gives the Reserve Bank of Australia scope to cut interest rates if needed.”
The release last Wednesday of a third-quarter consumer price index reading which showed a relatively tame increase means that the door is open for an interest-rate cut, perhaps as soon as the Reserve Bank of Australia’s next policy meeting, slated for Tuesday.
But the sell-off for iron ore may also only be temporary, and iron-ore prices may bounce back.
Hynes at Citigroup said that his base case is that underlying demand in China remains robust, and buyers will come back in the next two to three months to capitalize on weaker prices.