Supply problems continue to drive Iron ore price higher

The iron ore price has reached a two-year high this week, and with supply concerns in both Brazil and Australia continuing to rumble on, further gains seem likely.

Iron ore has been a curious outlier in the wider declines in the commodity sector, with the decline of Chinese growth failing to make a material impact upon the crucial base metal. The past year has been a volatile time for base metals, with the decline in Chinese growth highlighting a loss of demand, while the start of this year provided a welcome boost for many of these metals, we are now seeing declines across the board. Well almost.

The chart below highlights the different pathway seen in iron ore (green) compared with the likes of Copper (blue), Nickel and Zinc. With US-China trade talks seemingly declining into another deadlock, there is reason for traders to look at the base metal space as an area to short. However, what is different about iron ore, and will this outperformance continue?

As with any commodity, the price is typically dictated by the dynamic of supply and demand at any given point in time. When looking at iron ore, the story is typically centred around just three countries.

Iron ore demand

On the demand side it is difficult to look beyond China, with the Asian powerhouse accounting for around 65% of the total iron ore imports. Despite economic weakness in China, we have seen record demand from China despite the slowing economic growth rate. High profitability has driven steel producers in China to raise production, with output rising 12.7% in April to a record monthly level.

Iron ore supply

On the supply side, over 70% of the global supply comes from two nations; Australia and Brazil. Australia along accounts for 50% of the global exports, while Brazil provides more than 20% of the world's supply. Both countries have seen supply fall of late, with a cyclone in Australia and the collapse of a Vale-run mine in Brazil denting production heavily.

March saw cyclone Veronica strike the north-west of Australia, hitting a number of iron ore export hubs. It comes as no surprise that that we have seen output fall in response, and the impact of the storm may not be over yet. Rio Tinto has notified customers that they expect cyclone related repairs to finish by late June or early July. This highlights the continued impact from the cyclone, with output likely to remain subdued from the world’s largest iron ore exporting nation.

In Brazil, we have seen a huge backlash in response to the tragic collapse of a Vale mine, with over 230 people losing their lives. The response was understandably substantial, with Vale decommissioning all of the dams built using the upstream construction method (as was used at the Córrego do Feijão mine). The shift away from wet tailings has certainly dented supply, and it will take some time to adjust to any major changes in regulations that could arise as a result. One thing to note is that Vale have a substantial amount of iron ore stockpiles which could be utilised to take advantage of the ramp-up in prices. This week has seen talk of the firm ramping up output in their Carajas Serra Sul operation in the Amazon. A proposed rise to 150 million tonnes after 2020 is a clear shift given the prior plans to raise output to 100 million tonnes by 2022. However, it remains the case that all these supply issues will take some time, thus putting further upward pressure on the price of iron ore. The US-China trade talks may have hit a wall for now, yet with supply issues looking to rumble on for some time yet, we could see the eventual resolution of those talks drive Chinese growth and iron ore demand higher.

Iron ore price: what’s the outlook?

Looking at the iron ore chart, we can see the longer-term picture is certainly bullish following the breakout from a symmetrical triangle formation. The subsequent rise has been substantial and relatively consistent, with the price hitting a two year high this week. The next major resistance level comes in the form of the early 2017 high of 717, beyond which we are looking at record highs.

The daily chart highlights the recent surge, with an inside trendline providing support for the most recent rally. Watch out for whether we can sustain the price above 673 resistance to signal a further move higher from here. That does seem likely, with the uptrend expected to continue for some time yet. To the downside, we would need to see a break below 617 to negate this bullish trend and bring about a more negative view.


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