What goes up must come down. It’s cliched but, in the case of booming markets, it’s generally true.
And while there have been a few spectacular market booms over the past year, for sheer scale it’s hard to go past iron ore as one of the biggest.
Having shuffled along in a fairly narrow range between roughly $US80-100 a tonne in the months leading up to, and the early part of, the COVID pandemic, from May 2020 spot prices rocketed higher.
On May 12, 2021 the benchmark Chinese spot price for iron ore topped out at a whopping $US233 a tonne, more than two-and-a-half times what it had been a year earlier.
It may not have been quite as spectacular as Bitcoin’s near 10-fold annual increase between March 2020 and March 2021, but iron ore is not just a blockchain code stored on servers, it is a large-scale, crucial industrial commodity.
The crash is also somewhat reminiscent of recent crypto routs, with iron ore prices down about 40 per cent over the past month alone, having now fallen below $US130 a tonne.
Why iron ore’s sudden rise and fall?
So how did its price surge in a way more typical of a speculative financial asset, and why is it now crashing back even more rapidly than it rose?
There appear to be three main reasons for the boom and bust.
The first is China’s economic response to the pandemic. As usual, when the Chinese economy looks shaky, as it did after months of widespread COVID lockdowns, construction is the answer.
Building apartments and infrastructure requires steel, lots of it, and steel requires iron ore.
So demand was strong.
Then there was the effect of COVID on supply, namely out of Brazil.
Mines went out of action or cut production as workers came down with COVID-19, reducing global supply.
(As an aside, it may be a major reason why Western Australia is arguably the most zealous COVID-zero jurisdiction in the nation, having seen in Brazil the disruption the disease can cause on mine sites critical to its economy and royalty revenues.)
But Brazil is back, in a big way. As the COVID crisis has eased from its worst, UBS analysts estimate the South American nation has so far this year shipped about 12 per cent more iron ore than at the same point last year.
China’s falling demand
The biggest factor, though, is that this returning supply is coming into a market of falling demand.
There are two reasons for this.
One is that the Chinese economy is slowing more generally, particularly property and infrastructure, curtailing the outlook for steel and the raw materials needed to produce it.
“The infrastructure and property sectors account for 20-25 per cent and 25-30 per cent of China’s steel demand respectively,” noted Commonwealth Bank commodities analyst Vivek Dhar.
“We think part of the weakness in China’s steel demand is linked to widespread restrictions to contain China’s latest COVID-19 outbreak.”
The second is that China doesn’t want to increase steel output in 2021 compared to 2020.
The problem it has is that it produced too much in the first half of the year, so that if steel mills are to hit that target they will have to slash output by 11.6 per cent over the second half of the year.
And, even though they started cutting back heavily in July, the 8.4 per cent reduction compared to last year wasn’t enough, meaning output cuts have to increase further, and clearly appear to have done so in August so far.
Vivek Dhar is optimistic that Chinese authorities might soften their targets, as steel shortages start pushing up prices and therefore construction costs.
“We think policymakers will eventually relax steel output restrictions when steel prices increase because the steel output cuts prove to be more severe than any slowdown in China’s steel demand,” he wrote.
But there’s another factor that means China may actually clamp down even harder on steel output later this year and early next.
The Winter Olympics.
Running for just over a fortnight from February 4 next year, Chinese authorities won’t want a cloud of smog to hang over Beijing’s Winter Games.
If you have any doubt that China would shut down swathes of industry just to ensure clean air for a major public event, I can assure you from personal experience it happens.
I enjoyed unusually clean air and no traffic jams during my trip to Beijing in 2015 as the city removed half the cars from its roads (you could only drive your car on alternate days) and wound down many polluting industries ahead of a major military parade to mark 70 years since its victory over Japan in World War II.
“We expect China’s steel curtailments to be targeted in 4Q [the fourth quarter] when demand slows seasonally and air pollution is in focus (especially ahead of the Winter Olympics in Feb-22) and as a result we expect prices to stabilise in Sept/Oct before continuing to fall back below $US100/tonne in 2022,” wrote UBS analysts recently.
What does it mean for the economy and budget?
So what does all this mean for Australia, given that the record iron ore price boom and the nation’s massive output has provided much of the fiscal firepower to withstand COVID lockdowns and border closures?
Luckily, on the budget front, the government has remained much more pessimistic than most private sector analysts in its iron ore price forecasts.
The last budget assumed that spot prices would fall back to $US55 a tonne by the end of March next year.
We’re far from there yet, but Vivek Dhar says, if you draw a linear graph to get to that point, then spot prices are already tracking below that implied by the budget forecast.
“While higher prices in July 2021 still mean that the year-to-date average iron ore price for 2021-22 is still above the budget estimate, it’s only a matter of days before that reality reverses,” he warned.
“For every $US10/tonne decrease in the iron ore price relative to the budget forecast this financial year, Australia’s nominal GDP and federal government tax receipts are expected to fall $6.5 billion and $1.3 billion respectively.
“While we still think it’s unlikely for iron ore prices to fall as steeply as the budget forecasts in coming quarters, it’s certainly clear that iron ore prices may not be as positive for the Australian economy as hoped.”
The worry for Australia is that it’s not just iron ore prices falling either.
“Copper fell to its lowest price since April ($US8,894) down 1.92 per cent on the day and heading for its worst week in two months,” noted NAB’s Rodrigo Catril on Friday morning.
A falling Australian dollar should help, but it may hurt instead
The general China economic concerns, as well as other global fears about the increasing wave of Delta variant COVID-19 cases in many countries, are adding to the commodity price falls in whacking the Australian dollar.
“Risk aversion in the air has buoyed the greenback with pro-growth currencies bearing the brunt of it,” added Catril.
At 71.34 US cents, the Australian dollar is at its lowest point this year.
In normal times, that would be a big boost to economic growth, as it makes Australia’s exports more competitive and overseas imports less attractive.
But these aren’t normal times.
Most Australians can’t travel overseas anyway, so there’s no extra boost to domestic tourism from a lower dollar.
Overseas tourists definitely can’t visit Australia, so that benefit from a lower currency is gone too.
Australia’s biggest non-commodity export is education, and the lower dollar again doesn’t help much if students aren’t allowed into the country.
Then there’s the nasty side of a lower dollar for consumers — inflation.
A persistently weaker dollar will eventually make the price of imported goods rise.
While the Reserve Bank wants more inflation, it doesn’t want that kind of inflation, known as cost push, especially when that cost isn’t related to Australian workers’ wages rising.
Because, with many of the competitive benefits of a lower Australian dollar currently nullified by COVID-19 restrictions, it may be that a weaker currency simply makes Australian consumers relatively poorer and less able and willing to spend.
And that would be the last thing the economy needs as it tries to rebound once the latest lockdowns eventually lift.
Source: ABC News