Canary In The Iron Pit: Price Destruction From Massive Iron Ore Glut Gains Momentum
The worldwide money printing spree by central banks since the mid-1990s has produced a profound deformation of the commodity space. In the initial round, credit-fueled excess consumer demand in the DM world caused an enormous increase in consumption of industrial materials, leading to sharply rising prices.
As shown below, copper broke out of its $0.80/lbs. channel and eventually soared to $5. Similarly, iron ore had long been priced at around $20-25 per ton, but owing to the global consumption and industrial production boom of the last two decades it quickly climbed through $100 per ton and never looked back. By the 2012 peak it reached nearly $200 per ton—or a level 10X its historic norm.
Yet the spectacular trends shown in these graphs do not represent some unalloyed victory for “economic growth”, global capitalism or the liberation of Asian peasants from the un-monetized world of subsistence farming. All three of these notions are good things—but they got vastly and destructively overdone by statist economic policies. Nearly everywhere in the world after 1994, governments went all-in for massive credit expansion, heavy mercantilist trade subsidies and currency pegging and a historically unprecedented wave of investment in industrial and public infrastructure based on the availability of deeply subsidized, uneconomic capital.
Post 1994 Commodity Bubble – Click to enlarge
Needless to say, these policies did produce a temporary worldwide boom that has faltered twice since the mid-1990s, but both times has been re-ignited by resort to even more extreme bouts of money printing and state interventions and bailouts. As a result, the cumulative distortions, malinvesments, and unsustainable excesses have reached mind-boggling proportions.
At the heart of the global boom of the last two decades, of course, was a fantastic leap in credit expansion that has no historical antecedents. Around 1994 the combined credit market debt—public and private—of the US, EU, Japan and China amounted to about $35 trillion or 200% of GDP. By the turn of the century debt outstanding among these four major economies had doubled to $70 trillion, and then the central bank printing presses turned white hot.
Combined debt outstanding at present is in the order of $175 trillion, meaning that it towers 4X above levels of only 20 years ago, and weighs in a nearly 400% of GDP among the big four economies. And what happened to this $140 trillion of tsunami of new debt since 1994?
In the DM world it ended up on the balance sheets of households and governments which have now reached “peak debt” ratios, meaning that the credit fueled consumption party is over. Accordingly, what had been double digit growth for EM exports of manufactured goods to consumers in the DM markets has hit the flat line since the 2008 peak.
And in the EM world it ended up funding the most spectacular increase in mining, manufacturing, shipping, real estate and public infrastructure assets ever imagined by any economic scribbler prior to the turn of the century. Moreover, the artificial consumption boom in the DM world fueled the fixed asset boom in the EM based on the kind of mathematically impossible bullish extrapolations which always accompany a credit-fueled crack-up boom.
Yet when the housing and credit booms crashed in the DM world in 2009, the deep retrenchment of capital spending that was warranted in the EM supplier markets didn’t happen—except during a few brief months of panic and inventory liquidation in the winter of 2008-2009. Instead, the EM governments stepped into the breach, and launched a Keynesian pyramid building spree that surpassed by orders of magnitude any “stimulus” program ever conceived or imagined in the Harvard economics department.
Accordingly, global demand for the building blocks of fixed assets and infrastructure—that is, copper, iron ore, bauxite, nickel, hydrocarbons etc.——took another giant leap upward after the financial crisis. Indeed, CapEx by the big three surviving mining companies—BHP, Rio Tinto And Vale—soared by 10X during the decade ending in 2012.
But this wasn’t supply and demand doing its ordinary work in the marketplace. In the first round, demand for industrial materials was so rapidly and immensely expanded that the resulting price explosions produced historically unprecedented windfall profits on minerals in the ground and reserves delineated by previous investments. These spectacular returns reflected the fact that soaring markets prices vastly exceeded the cash costs of existing production and immediately available new exploration and development prospects.
Accordingly, capital flowed into mining investment in spectacular fashion. Moreover, the vast amounts of capital required turned out to be “dirt cheap”, as it were, owing to central bank-driven interest rate repression and debt accommodation on a worldwide basis. This begat, in turn, even greater investment flows into the iron ore provinces, for example, and in the associated capital-intensive infrastructure of processing, internal transport and global delivery by bulk carriers.
At that point the squirrel began chasing its own tail as the demand for structural and plate steel to build earthmovers, mining trucks, rail and port connections and giant dry-bulk carriers surged. These waves of demand for heavy capital equipment and ship-building, in turn, meant more demand on the steel mills and the iron ore needed to feed them. Around the circle of malinvesment they chased.
But now the music has stopped. The infrastructure binge in China—the leading edge of the global fixed asset boom—is being rapidly and desperately cooled down by the comrades in Beijing in order to avoid a veritable explosion of credit and speculation.
This braking action is now feeding through to a crisis just around the corner. Namely, China’s steel capacity of nearly 1.5 billion annual tons—15X that of the US—-is at least doubleits sustainable demand for sell through consumption goods like auto, appliances and industrial capital replacement.
At the moment, short-run demand is being sustained by a final surge of iron ore imports into China—which are being used not in steel furnaces but as collateral for off-shore borrowing. But that is not sustainable, and it means that the real adjustment of iron ore prices—which have already dropped to $100 per ton–is yet to come.
When iron ore plummets below $100 per ton it will herald the beginning of vast, sustained and devastating cycle of industrial asset deflation, and a veritable depression in industrial CapEx world wide.
Indeed, the canary is in the iron ore shaft, and already its wings are faltering, as the article below details.
By Jasmine Ng At Bloomberg News
Iron ore retreated to the lowest level since 2012, capping a fourth weekly loss and nearing $100 a ton, as increased seaborne supplies of the steel-making raw material boosted a global glut.
Ore with 62 percent content delivered to the Chinese port of Tianjin fell 1 percent to $102.70 a dry ton, the lowest level since September 2012, according to data from The Steel Index Ltd. The commodity dropped 23 percent this year, after falling 7.4 percent last year.
Iron ore entered a bear market in March as the world’s biggest mining companies including BHP Billiton Ltd. (BHP) expanded output from low-cost mines in Australia, betting that rising exports to China would more than offset lower prices. The commodity may decline below $100 going into next year as the surplus builds, Goldman Sachs Group Inc. said this week.
“We expect prices to go below $100 before the end of the year,” Ivan Szpakowski, a Hong Kong-based analyst at Citigroup Inc., said by phone today, forecasting averages of $102 for the third quarter and $100 in the final three months. “The biggest factor is probably still supply-side.”
Shares of BHP, the world’s third-largest iron ore exporter, fell 0.8 percent to A$37.34 at the close in Sydney, while Rio Tinto Group (RIO) declined 0.8 percent to A$60.95 and Fortescue Metals Group Ltd. lost 0.2 percent to A$4.81. In Brazil, Vale SA, the biggest exporter, declined 1.5 percent yesterday, taking this year’s retreat to 18 percent.
The global surplus will jump from 14 million tons last year to 77 million tons in 2014 and 145 million tons in 2015, Goldman Sachs said in a May 7 report. The increase led by new, low-cost output from Australia and Brazil will displace higher-cost supplies in China, Michiel Hovers, vice president of iron ore marketing at BHP, said at a conference in Singapore this week.
Prices of less than $100 a ton are too bearish, Claudio Alves, Vale’s global director of marketing and sales, told the same conference. Long-term prices are unlikely to go below that level, he said.
While spot prices could easily trade below $100 for a short time, they aren’t expected to maintain a six to 12-month average below that level for 12 to 18 months, said Lachlan Shaw, an analyst at Commonwealth Bank of Australia. A significant amount of high-cost Chinese capacity is still needed over the next year or two to meet China’s steel demand, Shaw wrote in an e-mail.
Operating costs at about 80 percent of China’s domestic iron ore mines are $80 to $90 a ton, according to Xia Yang, a Shanghai-based analyst at Mysteel, China’s biggest steel researcher. That compares with A$39 ($37) for Rio Tinto, A$41 for BHP and A$56 for Fortescue, according to UBS AG.
China’s imports jumped 24 percent to 83.4 million tons last month, figures from the customs administration showed yesterday. The country, the world’s largest steelmaker, and accounted for 68 percent of global shipments last year, Goldman estimates.
Iron ore dropped for a fifth month in April as stockpiles at ports increased, economic growth in China slowed and the government tightened credit. Gross domestic product is projected to expand 7.3 percent this year, according to a Bloomberg survey, compared with China’s official target of about 7.5 percent.
Steel production growth in China may slow to single-digit rates as mills face tight credit conditions as well as stricter environmental measures, according to Wang Xiaoqi, vice president of the China Iron and Steel Association. Steel output is expected to grow 3 percent to 4 percent this year and in 2015, Vale’s Alves said.
BHP last month raised its full-year production guidance to 217 million tons, while Rio Tinto reported record quarterly output. Fortescue (FMG) completed an expansion to almost triple capacity to 155 million tons.
“Early signs of a structural surplus are already evident,” Goldman analysts Christian Lelong and Amber Cai wrote in the May 7 report. “The Chinese cost curve will not prevent seaborne iron ore prices from crashing through the $100 level going into 2015.”
