Viewpoint: Iron Ore

FULL STEAM AHEAD?

BY BASIL KARATZAS

The iron ore rally seems to have lost steam for now, but capesize vessel freight rates imply otherwise

Any way one sees it, we all still live in a covid-19 world, whether we like it or not. Massive vaccinations notwithstanding and a lift of travel and mask-wearing restrictions in the western world may have given us a sense of normalcy – which is most welcome news after almost two years of lunacy – but the effects of covid-19 are affecting our lives in both visible and tangential ways today.

The prevailing logic has been that once a vaccine for covid-19 was found, the happy days of 2019 would have rolled back, as if flipping a switch. How naïve we all were! Although economic activity may have been recovering nicely since the covid-19 vaccine, recovery of industrial production has not been smooth, as factories have been short both of labour and of raw materials.

Shifting spending patterns by consumers have only made imbalances more exacerbated and through the “bullwhip effect”, supply chains have barely managed to keep up with demand and timely deliveries.

Coming out of covid-19, prices for commodities skyrocketed, as factories started revving up production to meet recovering demand and also as they were also trying to replenish inventories of raw materials and commodities at the same time, inventories that were depleted during the pandemic; mining companies, shippers, shipping operations and port terminals were all functioning via mountains of operational hurdles during the shutdowns and the inventory level was not among the highest of priorities.

rallying round

The commodities rally has been one of the strongest in the last decade. For example, the price of copper moved from approximately $2,300 per ton in early 2020 to almost $4,900 per ton in late 2021. The price of coal skyrocked from approximately $50 per ton to more than $300 per ton in the same period. The price of iron ore moved from below $80 per ton to approximately $225 per ton in the same period.

All in all, it had been an exceptional rally that probably allowed many traders to book huge profits in that period. Many an economist raised the prospect of inflationary concerns, but the general prevailing thinking has been about “transitory inflation”, the kind of price inflation that is not embedded in the economy and would have gone away once factories had a chance to replenish inventories.

Fast forward to the present, and by now, the discussion is about structural inflation that will force central banks to raise interest rates so high to cool the economies in order to curtail inflation. Add to the mix an active, unexpected and unpredictable warfront in the periphery of Europe that has turned energy markets upside down and now it’s not only a discussion of high interest rates, but also a discussion about stalled industrial production and possibly a recession.

price collapse

With the exception of energy prices (namely for crude oil, natural gas and coal) that remain at eye-popping levels due to geo-political events, the price for base commodities has collapsed since the beginning of the year: copper presently trades at $3,300 per ton (down 30% in six months) while iron ore now trades at $100 per ton (down by more than 50% in six months). Precious metals, grains and other commodities have all exhibited similar pricing patterns, in a veritable sense that misery loves company.

The proverbial jury is still out on the direction of the US and global economies, and the seesawing stock markets are the most obvious way to see the market’s “confusion”. Furthermore, an extremely strong US dollar does not help demand for commodities prices and there may be more pain ahead before the market finds its footing, but it would be hard to see that commodities prices will remain sustainably weak for long.

Taking a look at iron ore, the raw material for steel, it’s hard to believe that the world can do without it for long. For starters, despite China’s setbacks dealing with covid-19 and bringing their industrial production back to 2019 levels, President Xi Jinping has been vouching for China meeting its economic goals set for 2022, darkened economic horizons notwithstanding. An extremely strong US dollar does not help demand for commodities prices and there may be more pain ahead before the market finds its footing, but it would be hard to see that commodities prices will remain sustainably weak for long

strengthening market

Economics and growth statistics out of China have to be taken with a pinch of salt at the time, but as of July 2022, portside iron ore inventories in China stand at approximately 132m tons, the lowest level of inventories in the past ten months. Between the low inventories, a rekindling of Chinese production and also given that it takes more than a month to ship iron ore from Brazil to China, a strengthening of the iron ore market should be expected.

The chart shows historic freight costs for iron ore (in terms of US$ per ton shipped by capesize vessel) from Dampier in Australia and Tubarao in Brazil to Qingdao in China; the freight differential is well established between the two routes (given the distance differential), and the capesize freight rally nicely coincided with the rally in the iron ore price, for both routes.

Capesize rates for iron ore have come down, too, in the last six months, but freight rates are picking up steam again. If this is a kind of leading indicator, iron ore prices should be expected to tick up, too.

Basil M Karatzas is the Founder and CEO of Karatzas Marine Advisors & Co, a marine advisory and brokerage company based in New York. For more information please visit: karatzas.auction