Commodity prices have been on a wild ride over the past year and the white-knuckle journey seems unlikely to end any time soon. Indeed, the long-term contracts that used to be a feature of the iron ore market are long gone, and both supplier and consumers of this bulk mineral now have to deal with volatile spot prices and China’s often extreme inventory cycles.
As a result, investors in the resource sector should take note that iron ore prices are likely to be subject to often wild seasonal price swings through the year – prices tend to be stronger earlier in the year, then trail off by year end..
In turn, this reflects swings in Chinese demand. China’s iron ore demand tends to be stronger in the fourth and first quarters of each calendar year, as iron ore inventories are rebuilt, with prices tending to subside over the second and third quarters and inventories are wound back down again.
Price swings over the past two years illustrate this seasonality. Spot iron ore prices peaked at almost $US190/tonne in early 2011 then fell to a low of US$111 by November that year, only to then stage a recovery to almost US$150 by April 2012. Prices then subsided again, touching a low of US$87 by early September. We’ve since had an impressive rebound that has pushed prices to a recent high of $US155 in February. Prices have since started to slide again.
Based on recent cycles, we may well have already seen the iron ore price high for the year – and prices could again test US$100 by year end. Don’t say you weren’t warned.
Commodity prices – a history
Investors in resource stocks are probably getting used to these wild price swings, and in an efficient market resource company, share prices should not react as much. For longer-term investors, of course, the important issue is the long-term trend levels of iron ore prices and production – and commodities in general.
On this score, it’s likely that 2007 marked the peak in real commodity prices in this “super cycle” that began earlier last decade. By comparison with past “super cycles” in the late 1800s, 1920s, and in the 1940s-50s, the rise in prices – especially metal prices – over the past decade was especially strong, with real prices up around 200%. According to international research by the United Nations, the average gain in real prices during previous super cycle upswings has been around 90%.
The recent eight-year period of rising prices is broadly in line with the past three super cycles (which averaged 9.5 years), though considerably shorter than the 30-year period of rising real prices between the late 1800s and 1910. As is the way with cycles, high prices are starting to crimp demand (especially in developed economies) and encouraging a (belated) expansion in supply.
Challenges and opportunities
Of course, coal and iron ore prices did not peak until mid-way through last year – pushing Australia’s terms of trade (export prices relative to import prices) to historic highs. On the positive side, although the Chinese economy has slowed down, it’s a much bigger chunk of the global economy than it was a decade ago and still retains significant catch-up potential to meet the living standard of the West – and the steel intensity of other mighty industrial countries such as Korea. To sustain its solid rate of economic growth, China’s increasingly big challenge, however, will be to develop infrastructure in more remote regional areas.
That said, although Chinese coal and iron ore demand is likely to remain firm, the big dampener of prices in coming years will be increased supply, with all the major miners undertaking huge new expansion projects. Given the industry has become more concentrated, one issue is the extent to which the miners are collectively able to resist expanding supply (subject to anti-collusion laws) in order to hold up prices.
Either way, thankfully for Australia, both Rio and BHP-Billiton have significant expansion plans down under and could still make decent money even if iron ore prices slipped below US$100. Other more expensive miners, such as Fortescue, will be hoping prices can stay well north of US$100.
Volatility ahead
According to the latest research from the Bureau of Resources and Energy Economics (BREE), iron ore production should grow at close to a 10% annual rate over the next five years. But due to weakening prices, the value of production will grow at an annual rate of only 2.4%.
Indeed, world iron ore prices are expected to average US$119 over 2013 – and decline to an average price of US$90 (in today’s dollars) by 2018.
Annual coal production will grow by around 7% to 10% over this period, with annual growth in values of between 3% and 7%.
Even if right, investors can expect considerable volatility in prices around these trends.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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