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If we ride on the back of iron ore, the recovery signs are good

Iron ore prices have staged a remarkable comeback, boosted by a stronger Chinese economy and favourable weather conditions. It could deliver a bigger windfall to Australia than anyone thought.

One of the questions puzzling Australians and others bearish on China is why iron ore prices have risen 80% in the past five to months or so, including strong gains around the end of 2012 and into the new year when prices jumped by more than 25% alone.

The rise in global iron ore prices has been contrary to all those gloomy prognostications in mid-2012 through to November that Australia’s iron ore boom was over and we faced more pain. Last year iron ore imports ended up 8.4% at a record 743 million tonnes, worth $US95.6 billion. In fact, monthly import levels jumped from around October onwards to December’s records, while prices rose more than 60%.

In November, China’s crude steel production was 57.5 million tonnes, up by 13.7% from November 2011 (the figures for December and 2012 are due for release in the next day or so). No wonder prices nudged $US160 a tonne this week, again surprising analysts and others.

It’s a long way from the lows of last August and September when prices crashed to around $US87 a tonne, underlined by weak returns for the resources tax. But then iron ore prices started rising in October and November and this week remained around $US150 a tonne.

If that’s maintained, the proceeds from the resources tax should see some startling gains when the December and March quarter data are reported by the federal government in coming months.

Last week’s release of the monthly commodity price index showed the first upturn for seven months, with the index (in Australian dollar terms) at its highest since mid-year (it also rose in US dollar terms). The largest contributors to the rise in December were increases in the prices of iron ore, thermal coal and aluminium. Other base metals prices also increased in the month, while the price of gold fell. As the Reserve Bank noted:

Over the past year, the index has fallen by 8% in SDR terms. Much of this fall has been due to declines in the price of coking coal. The index has fallen by 11.5% in Australian dollar terms over the past year.”

Note the RBA is not blaming the recent weakness in iron ore prices for the fall. Terms of trade (forecast to plunge by the gloomsters) could remain steady or even rise slightly, even with the dollar around $US1.04.

So why the strong rebound in iron ore prices? Consider the following factors: a recovery in Chinese investment spending and demand from steel makers, the continued slide in supply from India, cyclones in Australia, the Chinese Lunar new year falling in February rather than January, drought and not heavy rains across much of Brazil’s iron ore producing regions and low water levels across the country’s huge hydro power catchments.

January-March is the quarter when iron ore shipments from Australia and Brazil are at most risk of disruption from cyclones (Australia) and heavy rain (Brazil). That has been the experience for the past three years — indeed, the combination of cyclones and the record rains and floods in Queensland in early 2011, coupled with heavy rain and floods in Brazil, were the drivers of the surge in iron ore prices past $US180 a tonne that year, and the surge in coking coal prices to more than $US280 a tonne as well.

With rising demand from Chinese steel mills restocking after running down inventories in mid-2012, mills boosted their imports of ore last month to a record 70.9 million tonnes, up 7.4% from November and more than 10% above the 64.1 million tonnes imported in December 2011.

The continuing slide in Indian exports is also a growing factor in forcing Chinese and other buyers in Asia to buy more ore from Australia and Brazil. Mining media have reported Indian steel mills and trading companies looking for iron ore import sources in Africa and other countries in Asia. And so far this month, the chances of another bout of heavy rain and floods in Brazil haven’t eventuated — there are media reports of possible power shortages caused by the sharp fall in water reserves in the country’s huge hydro power system.

Helping iron ore prices remain around $US150 a tonne has been cyclone Narelle, which is closing in on the Pilbara coast and could hit on Sunday. Rio Tinto has suspended ship loading at the ports of Dampier and Cape Lamber, but say mining operations and train movements are continuing for the moment.

And then there’s the health of the Chinese economy. Talk of its slide seem now to have been a bit premature. Industrial activity in the huge manufacturing sector is rebounding strongly, not only confirmed by the solid rise in iron ore prices and imports but by other import data as well. Trade figures for December and 2012, released yesterday, show exports rose 14.1% in December (a seven-month high) and imports were up 6% (in November they were flat).

The most telling import figure (apart from iron ore) was for oil: the country imported 23.67 million tonnes of crude oil last month, up 1.3% from November and 8% from December 2011. For the whole of 2012, imports rose 6.8% from 2011 to 271.02 million tonnes. In 2011, imports grew 6.05%. It also imported a net 15.5 million tonnes of refined oil products, up 4%. And Chinese bank lending for December and 2012 were also above most analyst estimates, indicating there may be easing credit conditions as the economy improves.

The real test for iron ore prices will come in February-May when the weather seasons in Australia and Brazil are over and they return to being driven by supply-demand factors (and an increasing level of financial speculation by investment banks, hedge funds and others). Then we will see the strength of prices tested.

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