Iron ore: value over volume

This article was prepared by Macquarie's Commodities Strategists for LME Week 2019.

24 October 2019

Seaborne iron ore delivered one of the strongest performances in our commodity cover this year, characterised by a surprisingly robust steel demand growth in China, technical industry issues in Australia and a dam failure in Brazil. Making iron ore’s performance completely at odds to the surplus-hit coal prices and the aggressive macro-cap on industrial metal prices.

We estimate that 3-5 per cent of seaborne supply was lost among the big three miners – Vale, Rio Tinto and BHP. This shortfall was partly offset by a supply lift in China, and among small producers across Australia and Brazil. But a seaborne deficit persisted well into 2H19, underpinning the year's collection of high product prices.

With mine production rates recovering in Brazil and Australia, prices are already falling back to pre-dam failure levels – a general shift that will compound Q4's seasonal pullback and drag on price performance in 2020. Only low inventories through the supply chain, particularly at China's ports and mills, potentially offset a faster price fall.

What’s next?

"However, in the long term, iron ore's growth outlook is set to be undermined by rising scrap flows across Asia and steel growth in China. "

The rate of recycling is likely to lift too, as China's central government continues to invest in scrap collecting capability and scrap-based electric arc furnaces (EAFs) – creating an inexorable structural shift that marginalises the current ore-consuming blast furnaces.

Where is the long-term upside in iron ore? Investor opportunities lie in improved quality segment. In a world of rising environmental pressures, demand for higher quality mill feedstock – high in iron grades, low in impurities – will lift indefinitely, delivered by a strategy shift to 'value-over-volume' by the major miners.