Iron Ore Soars, But Will the Pinch Between Supply and Demand Continue?

The price of iron ore is soaring, up more than 30% to around $145 per ton from $110 per ton at the end of October. Prices are up 60% year to date, massively outperforming even the levels seen before the March Covid-related correction. Iron ore has been well-supported throughout the year due to increased construction demand in China driven in part by infrastructure-led stimulus efforts. Chinese steel demand and output have remained strong, which bodes well for iron ore, the raw material that goes into the production of steel.

After its first-quarter shock in GDP, China is doing whatever it takes to make sure its reaches its fourth-quarter growth target of 6% to 7% GDP and to get the economy back on track to meet its annual 5% to 6% GDP targets. Despite the higher cost of iron ore, Chinese steel profit margins remain compelling to keep producing.

While demand is helping iron ore's price, so is a reduction in supply. Vale (VALE) , the world's largest producer of iron ore, lowered its iron ore production guidance for 2020 to a range of 300 million to 305 million tons from the previous 310 million to 330 million tons due to supply disruptions throughout the year. Its original forecast for 2020 was 340 million to 355 million tons. Vale's 2021 forecast has been set at an initial 320 million to 335 million tons, which is much lower than its first forecast for 2020.

China's trade data show iron ore imports topping a billion tons for the first time in the first 11 months of the year. For the first 10 months of 2020, iron ore imports rose to 975.2 million tons, up 11% from the like period a year earlier. Iron ore imports in October topped 106 million tons for the second month in a row. This double whammy of lower supply at a time of higher demand has led iron ore to be one of the best-performing commodities in 2020.

Covid-19 cases in Brazil have stabilized, but fears of further waves and related closures are key risks for less iron ore supply going forward. Brazil's iron ore exports are increasing given tensions between China and Australia picking up as China bans Australian coal. Australian iron ore imports have remained the same for now, but with unofficial stoppages and tariffs on wines and barley there are real risks of lower exports to China going forward.

For Australia, this is a huge risk. Exports of goods and services to China are about 7% of Australia's gross domestic product, and iron ore is the single-biggest category, at about 40% of the $153 billion in goods and services Australia sends to China every year, according to Department of Foreign Affairs and Trade figures. China consumes about 1 billion tons of iron ore a year, a little over 60% of which comes from Australia, and Brazil is the second-largest source, providing about 20%. There are alternatives, such as Africa, but they are likely far from displacing Australian iron ore given the extent of China's needs.

Iron ore supply is set to increase by 80 million to 100 million tons next year and there may be some supply normalization after Brazil's production shortfalls. However, demand is the unknown part of the equation. It is possible that China will start to take its foot off the pedal at some point in 2021 once it reaches its pre-Covid economic levels. But once President Biden comes into office it's likely that Democrats will push an infrastructure bill to boost the U.S. economy, which will be bullish for copper and Iron ore. Eurozone construction activity is negative at the moment, and there are hints of more infrastructure spending to come as European countries look for the quickest way to grow their way out of a recession.

With demand likely to fall from China and supply likely to pick up, iron ore prices could normalize at some point. But for now, the momentum is clearly up. 

At the time of publication, Bengali had no positions in the stocks mentioned.