Iron ore & copper on divergent price paths

As global growth retreats, in particular in Asia, demand for commodities is also dropping creating a surplus that is pressuring down prices. Iron ore, a commodity highly correlated with China’s growth, has seen its price in particular slashed by 45% since February last year as China’s growth has come off the boil. Copper in contrast is down just 15% in the same period. Is it time to invest in the market, or is the slowdown likely to continue?

BHP Billiton, Vale, and Rio Tinto – three of the major iron ore suppliers controlling two-thirds of seaborne iron ore have all been expanding production but themselves aren’t bullish about future prospects for the market. The Reserve Bank of Australia is also concerned and in fact cut its key interest rate earlier this week on growth woes and especially because of a worsening outlook for Australian commodity industries.

China buys more than 60% of all iron ore shipped by sea – a significant part of the whole world consumption as government infrastructure investment has been accounting for almost 50% of domestic GDP. The Chinese economic reforms which started in 1978 led the country to engage in large infrastructure projects, effectively rebuilding a whole new economy and in the process, becoming the largest world iron ore consumer. As a result, iron ore experienced one of the biggest bull markets an industry could have – more than 20 years of expansion and price appreciation. It seems hard to believe but iron ore was valued at less than $13 per metric ton in 2002 and hit $190 in February last year, a hooping 1360% rise.

As the Chinese economy is approaching the end of a political cycle (the Communist party congress is just under way and will result in changes in national and regional government), the People’s Bank of China is likely to cut its key interest rate as quickly as in the past and, as the government is not rushing to approve a stimulus package similar to 2008’s, their economy is continuing to modestly slow and politicians there are trying to engineer a change from an infrastructure dependent to consumer-based economy. As Chinese growth has been cut, demand expectations for iron ore have also been cut. Adding to this, the industry also suffers from a rising supply side and that is also likely continue to remain so in the near future.

The rise in iron ore prices led many commodity companies to boost demand,  invest in new projects and bring new companies to the public markets. The market will take time to consolidate and iron ore prices look likely to be further pressured the next year. Analysts are expecting a bear market similar to what happened in 92-94. China may try to boost its economy in the fourth quarter of the year and induce some recovery in iron ore prices but the trend is negative in the medium to long-run.

Copper is another metal suffering from global growth concerns but has better prospects than iron ore mostly due to its supply side. While iron ore has seen supply growing, copper has supply problems that give some price support. QE3 also helps copper even though silver and gold are better targets.