Over the past 48 hours of trade, iron ore with Fe+ 62% concentrate into the port of Tianjin has fallen from US$114.20 a tonne to US$104.7 a tonne (-8.8%) as fear-selling kicks in on the back of the first credit default on China’s bond market on Friday, which raised credit crunch fears.
What is amplifying the fear is the weak CPI print, which continues to slide despite the fact the target figure of 3.5% was confirmed at the National People’s Congress last week. At 2% inflation, demand certainly seems to be fading which is going to impact on the physical uptake of steel as industry and consumers alike slow consumption.
In addition, the export number released over the weekend was exceptionally weak; with exports off 18.1%. Chinese Luna New Year can be blamed for some of this fall, however the rate of decline is certainly harder and faster than forecast and is a concern which is increasing the interim pressure.
Financing is also impacting the iron ore price. According to China’s Mysteel, iron ore inventory at Chinese ports hit 108.6 million tonnes; that is near record highs and can explain demand worries. However, what is making the market even more nervous is the finance connected to iron ore.
Under normal commercial trading, banks are happy to accept ore or commodities as collateral for loans. Normally copper is the preferred commodity, however iron ore has been steadily increasing its position on the banks collateral list. But iron ore’s value is much lower and the volume required is much higher. Currently one cubic metre of copper is equivalent to 180 cubic metres iron ore.
With that in mind, analysts currently believe one third of the iron ore held at Chinese ports is under financing agreements versus normal conditions of around 10%. This has created a double-edged credit problem; it has artificially inflated the iron ore price as demand for collateral boosted iron ore imports which lead to average prices of $130 to $135 a tonne in the back end of 2013.
What is making this situation even more concerning is it is believed most of the inventory purchases are unhedged. This means margin calls are coming thick and fast and losses are mounting. This could see inventory-dumping as losses become unsustainable.
The more likely scenario is banks take control of the inventory as traders default. However it is unlikely the banks will dump the cargo on market until prices recover. This should moderate the dumping effect and I would therefore expect a levelling of the current decline as banks take control of supply.
What is also supportive of a short lived drop in the iron ore price is steel mills have seen inventories decline over the month of February as production increased at the back end of the month. It is likely that bargain hunting will kick in as April-May tends to see seasonal demand for steel increase.
While the current trend is lower, this is likely to be a short term event. We see the iron ore outage lasting for days to weeks but no longer, it will adversely impact pure plays and mega producers alike and current volumes suggest the bears are in full control.
However, once there is stabilisation in the price and demand is confirmed from steel mills and imports alike, expect a positive pop for material plays.