As Axiom Capital’s Gordon Johnson points out, Iron Ore stocks at Chinese ports just hit a new record high in the last week of 2016, even as the spot price of iron ore staged a dramatic comeback over 2016, closing near the highs of the year. However, as Johnson notes, if history is any precedent, such record stocks “carry an ominous sign for iron ore prices.” Here’s why.
After jumping by the biggest 1-wk increase since Oct. ’15, +2.7% w/w, iron ore inventories at Chinese ports reached a new record high of 114.0Mmt on 12/30.
Using implied consumption as a denominator (i.e., the latest data on daily pig iron output x 1.6), days of inventory for port stocks topped 38.6, the most in 2-yrs.
While inventory restocking at China’s ports likely helped support prices, w/ an intense destock likely in the offing, Johnon sees “downside risk to prices as imminent.”
How much? Well, using the last big peak-to-trough cycle as a guide, 7/4/14-6/26/15, port stocks & avg. wkly spot prices fell 30.2% & 35.5%, respectively. Further, since the 7/4/14 peak, stocks/prices shared a 65% correl. Assuming stocks fall just half as much as in the last down cycle, using a simple regression, we est., ceteris paribus, prices could quickly fall back to $61/mt (Ex. 3).
One of the reasons cited for the massive stockpiling of iron ore is that China is planning a vast expansion of its railway network to support growth, with new lines estd. to span >18K miles (link).
However, as Axiom boldly notes, “China’s Massive Railway Expansion Plan ? a Panacea for Iron Ore or Steel Demand.“
While this would surely benefit jobs, Axiom estimates with a few assumptions, that the incremental benefit to aggregate steel demand would be a mere 4.8Mmtpa, or just 59bps over 806.7Mmt of estd. ’16 production.
How does it get here? Using publicly available data from WAB (NC) as a blueprint (link), assuming avg. weights for: (1) rails are 128lbs./yd., (2) joint bars are 90lbs./pair, (3) track bolts are 80lbs./yd., & (4) spikes are 59lbs./yd., Johnson estimates avg. steel demand of 448mt/mile of track (Ex. 4).
The firm further, and rather aggressively, assumes this expansion is completed in just 3.5yrs & all rail lines are double-track. What’s more, w/ ~90% of steel made in blast furnaces, we est. this incremental steel demand would translate to 6.9Mmtpa of iron ore demand, or just 59bps against an estd. 1,165Mmt of gross ’16 supply (i.e., 141Mmt in domestic output + 1,024Mmt of imports [Ex. 5]).
Bottom line: according to Axiom, both China’s iron ore demand, and the recent price surge, have topped out, especially following recent Beijing summits in which the topic of deflating China’s various bubbles is once again front and center. Finally, the recent downturn in the Baltic Dry Index may suggest that the spot price correction is set to arrive sooner than many expected.
Source: zero hedge