Bulk Commodity Analytics & Research - Market Compass May 19, 2021

Iron Ore:

Common sense prevailed last week, with a little helping nudge in the right direction from the Chinese government in the second half of the week.

While China spotlighted steel market manipulation, fearmongering, and hoarding, it has been equally culpable for the impact its rhetoric has had on stoking futures speculation.

SGX June Iron Ore futures corrected from a peak of US$234/t CFR China on 12^th May, breaking through our short-term target (US$190/t) on 14^th May before closing the week out at US$198/t.

The danger with speculative rallies is that it is always very little in the way of actual real fundamentals underpinning parabolic and volatile swings.

Idealistically, we expected (and hoped) this “flawed” system would eventually revert towards true supply-demand fundamentals, which appeared to be soothing last week.

Chinese BF capacity utilization rates plateaued*, iron ore arrivals remained robust**, and the Chinese govt cracked its whip***. N.B.*- denotes degree of importance (*low, ***high)

While Chinese blast furnaces can accommodate theoretical iron ore costs of US$230/t++ given absurd steel margins, end-use sectors (construction) simply cannot afford inflated steel prices.

First signs of demand destruction now starting to appear as inflationary pressure feeds further downstream in the steel supply chain, impacting restocking and construction activity.

SGX iron ore futures rebounding this morning as reduced arrivals from Australia and Brazil landed w/e 16^th May putting pressure, albeit temporarily, on portside stockpiles.

Short-Term Outlook:

Steel demand destruction will slow restocking and construction activity, capping steel prices and margins which have recently been a major determining factor for iron ore pricing.

We maintain our short-term target at around US$190/t CFR China as we expect a material increase in iron ore arrivals w/e 23^rd May and slower steel inventory depletion to narrow wide margins.

Medium-Term Outlook:

We maintain our medium-term target of US$160-180/t CFR China based on robust arrivals & shipments of iron ore through Q2 and increasing likelihood of steel demand destruction.

Upside Risks:

Rest of the World and Chinese stimulus-driven blast furnace output rebounds faster than expected, paring, or even exceeding, anticipated increase in Q2 iron ore production volumes – probable.

Hot money and speculative longs continue to control direction & momentum, overreacting to and misinterpreting market events – paid out & probable.

Downside Risks:

Overinflated Chinese steel prices destroying local demand given that end users cannot afford to purchase stock under existing project budgets –probable.

Brazil achieves significant reduction in COVID-19 infection rates enabling local iron ore miners to raise domestic production – possible.

China enforces strict blast furnace capacity restrictions, prompting end-users to source steel supply from seaborne markets – improbable.

Ferrous Scrap:

Turkish purchasing activity remained robust last week though pricing action lost a bit of momentum as it met resistance just above our short-term target of US$501/t CFR Turkey.

Once again, Turkish mills have upwardly revised domestic rebar benchmarks passing on more than the total increase in ferrous scrap costs to end-users, with spreads now standing at US$223/t.

In a bull market, steel producers greatly benefit from higher production costs given that the same % margin provides higher absolute return/value.

We understand that this round of Turkish bookings is not entirely complete – yet. Providing further but modest upside risk in the current round of negotiations.

We maintain May-July is a robust period for Turkish steel consumption and output, particularly rebar, in response to peak construction of commercial buildings and utility projects over this period.

Following the (anticipated) correction in iron ore prices, the scope for runaway upside risk in ferrous scrap prices has significantly abated.

Short-Term Outlook:

Ferrous scrap suppliers unlikely to claw back more than US$40-50/t (ceteris paribus) given that this would overvalue its value-in-use versus hot metal production costs.

We do not believe this will be digested in the current round of negotiations, and it will be staggered with ebb & flow of Turkish buying patterns, upgrading short-term target to US$523/t CFR Turkey.

Medium-Term Outlook:

We maintain our expectations that iron ore prices will correct towards US$190/t as high Chinese steel prices and margins impact local demand (see Iron Ore & Steel).

That said, the longer 62%Iron Ore Fines prices remain above US$190/t CFR China, the greater the pressure builds for ferrous scrap use, upgrading medium-term, target to US$552/t CFR Turkey.

Upside Risks:

Robust hot metal production costs, particularly for iron ore, increase the competitiveness of ferrous scrap, prompting EAFs and BOFs to increase consumption and usage rates – paid out & probable.

Distorted iron ore prices caused by futures markets could reverberate through the physical steel supply chain, driving ferrous scrap prices even higher – improbable.

Downside Risks:

Chinese steel demand destruction could reverberate through the global ferrous supply chain, hitting steel prices & margins, driving iron ore/hot metal production costs lower – probable.

Central Bank governorship and interest rate policy potentially becoming more ‘dovish’ i.e. lower interest rates for longer, resulting in further depreciation of Turkish lira – probable.

Peaking Turkish COVID-19 infection rates prompt the government to impose a fresh national lockdown (paidout), impacting construction of commercial and utility projects (improbable).

Steel:

SHFE October steel rebar futures contract traded as high as RMB6,200/t last week, before plummeting as low as RMB5,541/t this morning – demonstrating the fragility of speculative rallies.

Late last week, Shanghai and Tangshan authorities urged mills to “set prices reasonably” and that “companies must not fabricate or spread price increase information to disrupt market order”.

While govt statements on steel capacity reforms were well-intended (carbon-neutrality), frequency & incoordination was the accelerant that fueled recent speculative rallies.

SHFE investors misinterpreted “capacity reforms” to mean “lower output and even tighter supply-demand balance”, when in fact China still has approximately 10% latent steelmaking capacity.

As we mentioned last week, commodity price inflation and volatility would significantly reduce economic impact of govt stimulus measures.

Unsurprisingly, some Chinese constructors now suspending projects, significantly reducing restocking volumes & buying hand-to-mouth as stellar steel prices have slaughtered profitability.

We anticipate that this steel demand destruction, caused by overinflated steel prices, will be a nationwide phenomenon, resulting in slower depletion, or even build-up, of steel inventories.

Short-Term Outlook:

Greater attention from authorities and industry regulators should cap future speculative moves, maintain short-term target at RMB5,400-5,500/t (US$832-848/t) EXW Shanghai.

Medium-Term Outlook:

Market shows it has potential to correct RMB700/t in a week, demand destruction & higher output should tip S&D balance – maintain medium-term target at RMB4,500/t (US$690/t) EXW Shanghai.

Upside Risks:

Government forces steel mills, who can no longer viably export steel or retool to produce alternative steel products, to shut up shop – probable.

India’s COVID-19 outbreak afflicts domestic steel production and exports, tightening global steel supply chains further – probable.

SHFE steel rebar retail investors continue to overreact to fresh news of capacity reforms & restrictions – paid out & possible.

Domestic stimulus-driven steel consumption, particularly for long products, expands at a much faster pace through the remainder of the year – possible.

Downside Risks:

Overinflated Chinese steel prices destroying local demand given that end users cannot afford to purchase stock under existing project budgets – probable.

China reduces or cancels steel export tax rebates (paid out) resulting in increased domestic availability of flat-rolled products, limited impact on long products (bars & rods) – probable.

Government eases stance on emissions targets sooner rather than later (improbable), allowing latent steelmaking capacity to service robust consumption (probable).

Rebounding Australian iron ore production & shipments remove support from hot metal; production costs & steel prices through the second quarter – improbable.

Courtesy: Navigate Commodities