Chinese iron ore buying will need coking coal eventually

Today’s report that iron ore prices have hit their highest since July could eventually bode well for the coking coal because it could be seen as a signal that the Chinese will run down their huge coking coal supplies at a faster rate.

“No one is really chasing the market hard, but it appears that the Chinese are soaking up the volume of [iron ore] cargoes on offer. I think some of the iron ore traders are betting the leadership transition will provide the catalyst for a resurgence in iron ore demand, while mills are also restocking supplies and daily crude steel output is at near record levels seen earlier in the year,” said Jamie Pearce, head of iron ore broking at SSY Futures.

Coking coal did not accompany the iron ore in its price rise and some say that Chinese first need to run down their coking coal supplies they acquired in huge amounts during the first half of the year. So, if the pace of the iron ore usage is increasing than one is to expect that the burn rate in the coking coal inventories should accelerate as well.

With many coking coal miners operating at slim inventories and no prospects in cranking up the output this suggests that coking coal may have bottomed significantly and that it could, going forward, rise slightly.

Such scenario could benefit names like WLT, BTU and ANR.

This scenario, however, is contrary to what S&P suggested yesterday after it downgraded Walter Energy (WLT) debt into junk on a presumption that coking coal prices will go lower in 2013 and, as a result, cause debt problems for this miner.

Copper, iron ore signaling different things

Iron ore prices have been falling as of late much more so than the price of copper, a metal that the ore is very well correlated with, so a question that pops out of this price divergence is which price move, the ore’s drop or copper’s steadiness, is a correct signal as to what is going on in the global growth space, particularly in China.

“In truth, neither iron ore nor copper is a very pristine mirror on the state of manufacturing activity, either globally or in China itself. Copper is over-financialised. Iron ore is under-financialised,” writes Andy Home, a Reuters columnist.

He also says that the iron ore price is not just linked to China but made there and in many ways, it is not a global price.

But so is with copper in many of the same ways despite being financialized and subject to speculative attributes rather then attributes of the supply and demand: copper’s meteoric price rise in last 5 years has been predicated on growth and export specter in China and now that both are falling why isn’t copper as well.

With storage space controlled by the same big box financial outfits that trade copper on the financial market, physical deliveries of the metal are artificially constrained, costing the users a premium that jacks up the marginal cost of production. Glencore’s relentless pursuit to purchase Xtrata, moreover, is showing that some of these big trading players are also eyeballing to completely vertically integrate and exert dominance over every level of commodity production and delivery.

With the advent of the ETFs and lax regulation that allows speculators in metals to exert physical control over stuff they trade, western economies, indeed global, have been undergoing a massive taxation that amounts to a wealth transfer from producers to the financial sector.

This is also true of oil and if the legislators succumb to the demands of the big box financial houses, virtually any standardized product could come under their controlling spell, have its own ETF, be subject to speculative sentiment… As a digressive exhibit, witness Citigroup Chief Economist Willem Buiter’s musings on how and why water should be subject to financialization.

Anyway, one resultant of the collapsing iron ore price is a slew of project cancellations by the Australian miners. Some $246 billion in investments is being sidelined a bankers become concerned about what is it that they are funding.

In another sign that what happened to iron ore maybe a macroeconomic tipping point is not just the mining investment but also the employment picture in Australia, disproportionately bloated and swelled.

The employment in Australia’s mining sector dropped 4,600, the first quarterly drop since mid-2009, and more lay-offs are expected. With Chinese signaling that they view any massive stimulus a detriment to Chinese economic health, negative datapoints in Australia ought to pop up with more frequency going forward.

Having said all this, will copper go lower to recorrelate with the iron ore or the other way around?

Short-term odds favor the upside in the ore as the strong mining hands step up and scoop up the bargain while central banks inject liquidity boosting copper. The story over the longer-term looks more negative and it is worth remembering these negative headwinds once the long-term arrives.

Iron ore bounce maybe followed with more selling

Recently one of the Fast Money boys was saying that iron ore sell off is overdone because Chinese users are playing the miners and deliberately postponing their orders for this steel making input.

If it’s deliberate and not out of need, than why would they postpone payments for another steel making input – coal?

From Reuters:

A 20 percent increase in the amount of money clients owe to companies in China’s coal, steel and heavy machinery sectors is pointing to an industry wide shakeout that threatens to put some smaller firms out of business.

Account receivables – meaning unpaid bills yet to be received – were at staggering $1.13 trillion and situation in steel, coal and machinery is described as grave.

“There are no signs of economic recovery. The government is reluctant to implement any stimulus measures. The situation will get worse by the end of this year and even worse by the middle of next year,” said Helen Lau, senior analyst at UOB Kay Hian (Hong Kong) Research.

“A lot of smaller firms will default because they are financially weak and may not be able to get financing from banks. This is a natural market-driven market consolidation.”

Such reports show that the iron ore sell off is done not out of deliberation but out of financial necessity.

Over the last several sessions, iron ore rose by $13 and this 15.2% rise is backed by Chinese promises to spend money on projects. But some question how long this last will.

“Iron ore prices could continue to gain over the next week or two, but I still question the long-term sustainability of this given the weak steel fundamentals. For the rest of this year you’re not going to see a great deal of flow-through demand from those construction projects. Therefore I don’t think an iron ore rally has a hell of a lot in it for the rest of this year.” said Rory MacDonald, iron ore broker at Freight Investor Services.

What’s driving this iron ore rally looks like sentiment rather than the fundamentals, a situation that will eventually right itself.

Can small China iron ore traders trigger avalanche

Chinese are dumping steel on international markets, cutting on production while Chinese traders are holding huge stocks of iron ore but now, these small Chinese traders, burdened by costs of holding that inventory, are buckling under lack of any revival in demand and getting rid of their iron ore inventory.

“Quite a lot of the port inventories have been stuck there for over a year, so the main objective for these smaller traders now is to sell whatever they can to stem further losses. Few are holding out hopes that the iron ore market would boom again, so they’d rather cash out and use the money for other investments,” says an unnamed Chinese trader.

The big trading outfits may hold off on the losses for longer but trends with the small traders are significant because Chinese iron ore market is fragmented into thousands of small ore dealers who are sensitive to price swings and demand.

“The issue is that small traders are getting their iron ore supplies at around $135 a tonne, so after the iron ore price declined for two weeks they have to sell,” said Henry Liu, commodity analyst with Mirae Asset Securities in Hong Kong.

Iron ore now goes for about $123 per ton.

But what if these thousands of small traders sink the price sufficiently so that the big boys would have to rethink as to how wise is to sit on stockpiles of unwanted ore?

If big Chinese traders are to follow the small guys, about 100 million tons of iron ore could suddenly get unleashed. At about 62 million tons per month of average iron ore imports, these stocks would account for little less than 2 months of China’s iron ore imports.

Such development could be a huge negative for the likes of BHP Billiton and Rio Tinto because of their large exposure to China and plans to expand their production.

Earlier in the month, for example, BHP announced that it plans to “lift Australian iron ore output by 5 percent in the 2013 financial year, despite risks of cooling demand in top customer China.” In fact, Australia’s Bureau of Resources and Energy Economics sees iron ore experts to rise 10% for 2013.

Now, 2013 is longer way off which gives some room for the Chinese stimulus to pick up steam among steel makers who are, in the short term, unlikely to benefit from the stimulus, at least not until sometimes in Q4. This leaves a 1-2 month vacuum that could unleash some major iron ore selling.

“It is expensive for small traders to hold stocks. They have to consider port fees, storage fees, logistics and other financing costs. It would have been manageable if demand hasn’t been so weak and if the outlook wasn’t uncertain. Small traders can either choose to sell at a loss or choose to die,” says an iron ore trader with a large state-owned trading company in Shanghai.

We have to see if this turns into an iron ore avalanche.

Gloom over Chinese steel

Chinese officials still cling to a claim that in 2012 the demand for steel will actually rise, by 4%, according to the chairman of the China Iron and Steel Association.

“Enterprises are facing increasing operating risks, under pressure from a variety of factors such as [1] rising costs, [2] falling demand and [3] difficult and expensive financing,” said the chairman.

One does not have confidence that his 4% growth projection is based on any change in any one of the 3 variables he cites, particularly variable [2].

From Reuters:

Rapid capacity expansion and record levels of steel output helped drive iron ore prices close to $200 per tonne for much of last year, but analysts are concerned that China’s steel bubble has now well and truly burst.

Linear projections, like the chairman’s, typically do not work in post-bubble environments.

Head of commodity research at Mirae Asset Securities says that “Some [steel] traders have closed their business for January”.

Chief executive of Beijing Metal Consulting, Xu Zhongbo, says that during the last cycle in 2008, mills expanded production in expectations of the huge stimulus but there is no such stimulus this time and these mills are now loaded with debt.

Impact on iron ore prices?

“This year is a turning point – at the moment small mills are still buying iron ore and keeping prices at about $130-140 per tonne, but now 80 percent of mills are making losses, including the small ones,” Xu said.

Seems that, eventually, these iron ore purchases would slump, not just because of falling demand but probably from disappearance of some of these steel makers.

We also see that Australia’s exuberant politicians are already questioning whether the proposed mining profits tax will raise any of the projected revenue, with iron ore and coal comprising lions share of these imagined tax-dollars.

Sure that Vale has finally managed to get its iron ore supertankers to dock in China, but this should be an additional reason to be, if not negative, but then at least cautious on names like BHP, RIO, some coking coal names and the Australian dollar.

Iron ore imports surge in China in November

Iron ore imports surged in China in November sequentially, a data point that is somewhat counter to a narrative of a slowdown in Chinese industrial sector.

The surge comes as steel mills there are idling even though the state-owned China Securities Journal says that steel should be robust in 2012 with demand marginally higher. China’s Minister of Industry and Information also noted that industrial output is expected to grow 11% in 2012, down from an estimated 13.9% in 2011.

China is expected to keep pressing on the property market and expand a pilot property tax program to curb speculation. This could cap steel demand.

Iron ore is also part of a drama that is enveloping in China with Vale forging on with its ore supertanker.

Vale is spending billions to build a fleet of 35 giant vessels with 400,000 ton capacity each as it seeks to cut shipping costs but it has had great deal of difficulty of getting an official Chinese approval to dock the ships.

Influential Chinese ship owners and steel makers are lobbying against Vale fearing that the move is an attempt by Vale to monopolize both shipping and iron ore markets in China, at their expense.

In June, one of Vale’s ships was made to turn back in the Indian ocean after authorities disallowed its docking. China Shipowners Association says they are worried about the safety of these superships citing a leak that was found prior to sailing.

Yesterday, Vale managed to dock its first ship of iron ore.

As with all the markets, iron ore trading is silent in China.

Prices peaked at about $200 per ton in February and since remained in  $170-$180 range until October, when iron ore dropped $50 per ton on fears about the Chinese economy.

BHP Billiton finally admits slowdown

Up until recently, BHP Billiton was saying that things in the mining space were good and that stuff like iron ore is going brisk despite cuts in global steel production by the major producers.

Well, today BHP Billiton is finally admitting that commodity markets are under pressure.

“The heightened volatility and uncertain economic outlook are expected to continue to weigh on sentiment in the markets for our commodities,” BHP Billiton’s Chief Executive Marius Kloppers told shareholders at the group’s annual meeting in Australia.

Until recently, BHP Billiton, only used volatility and not “uncertain economic outlook” in his description of the market.

Rio and Vale also omit the “uncertain economic outlook” phase and just emphasize the volatility.

More on troubles in the steel space here.

More evidence of trouble in steel, ore, coal

China’s Iron and Steel Association is sayingthat steel mills are not buying iron ore.

“In my personal opinion, the price of imported iron ore will fall further, because the trends for the whole sector are unlikely to get better and steel mills don’t dare to buy ore,” said Zhang Changfu, the vice-chairman of the China Iron and Steel Association.

Lack ore buying in China mean’s that inventories are high there implying that steel is not being produced.

China’s Baoshan Iron & Steel Co confirmed the ore pricing downtrend by saying that there may eventually be iron ore oversupply.

“I expect the current tightness in iron ore supplies to ease by around end-2012 or 2013. The market may even reverse to be oversupplied after a flurry of mine investments,” Baosteel General manager Ma Guoqiang said during an online results briefing.

Baoshan “results” were rather bad registering a 51% drop in profit for its Q3.

As for Chinese steel profits in general, news agency Xinhua reports today that most of the profits these firm made this year do not come from their steel operations but “largely came from the companies’ mines, power plants and investments rather than steel business”.

“The companies’ average rate of profit in selling steel products was only 2.99 percent in the period, significantly lower than that of the country’s other sectors,” says Xinhua.

In Europe, steelmakers are looking at a substantial slowdown as recession takes hold there. Swedish specialty steel maker SSAB said on Friday it faced an uncertain outlook for prices and demand. Several steel mills have already been shit down in Europe.

Korea’s POSCO is has also issued a gloomy outlook saying that their profits will be down and steel prices will decline.

Last week, Japan’s Nippon Steel and JFE Holdings slashed full-year expectations by 20%.

In the US, Nucor Corp and U.S. Steel warned of weak demand for the remainder of the year.

“I’m rather cautious on steel in 2012. I see lower demand from the automotive and construction sectors and only growth in engineering,” said Ingo Schachel, analyst at Commerzbank.

Another steel input commodity, coking coal, may also suffer as a result of this global shave-down on steel. Last week, a sign that coke is entering into trouble has been noted by the Czech coal miner New World Resources (NWR) which sees dropping prices and demand. NWR has slashed its sales forecast by over 20% saying that they will not be able to sell the planned 720,000 tons of coking coal in 2011 and now expect between 525-575,000 tins.

Yet in Brazil, the message is different.

Iron ore producer, Vale says it plans not to reduce iron ore output and says that recent price drop is a blip.

Brazil’s steelmaker CSN also believes that they will sell more iron ore and steel in 2012.

“Their [CSN] estimates for next year look too optimistic. There are serious downside risks for both ore and in the months ahead,” said Pedro Galdi, head of research with SLW Corretora in Sao Paulo.

More evidence about prospects of steel will come this Thursday when ArcelorMittal reports its results. ArcelorMittal produces 7% of global steel so what they say would be very important.

The negatives of global steel

Iron ore, one of the few non-financialized commodities, is not doing so well. Prices have dropped 11% in a week and Chinese steel makers, considered the last of the drivers for the iron ore demand, are signaling a major slowdown in output.

While copper is dubbed a metal with a PhD in economics because of it correlation with the asset prices, iron ore lacks some of the speculative dimensions copper has: end users rather than traders dominate the iron ore market. Nor is iron ore supply constrained by warehouse storage controlled by big banks.

Having said this, Chinese steel makers are saying that they are worried that their customers will default on their orders and that others are delaying them, citing problems in financing due to Chinese tight money policy.

Meanwhile, Japanese steel makers are slashing production and lowering expected output. European steel makers are doing the same.

All of this added up does not look good for the global industrial output nor does it look good for the iron ore prices.

According to Brazil’s Vale, however, none of this matters. Vale is saying that it will not cut its production and believes that the price slump is a temporary blip. Vale’s comments came after its earnings missed the expectations.

Vale’s two other competitors, BHP Billiton and Rio Tinto, may do the same just to maintain their market share position.

If robust iron ore production targets are maintained, it is reasonable to presume – let’s be conservative and says – that iron ore prices do not have a bullish case.

An analyst with Stanchart Bank in Shanghai, Judy Zhu, confirms this.

“Steel demand is very poor. There is hardly any restocking going on because buyers are cash strapped and there are growing worries of a further slowdown in the property sector. I don’t expect Beijing to start easing until early next year, which means it would be difficult for steel demand to improve markedly,” Zhu says.

Moreover, a hope that China will soon loosen up its tight money may be just that because at 6% Chinese inflation is still too high.

Tight money may tighten steel supply as well as many smaller steel makers could be forced out of business.

A derivative bearish case could be also made or another steel making input – coking coal. If all these negatives are possible in the steel space, along with iron ore, coking coal definitively does not look promising.

With China slowing and Europe heading into a recession, there should be some suspicion as to where iron ore and coking coal are heading to, and with this the names that are involved in this business.

Steel inputs moving towards short-term pricing

Now that the world’s three largest iron ore producers have established a near oligopoly, the pricing of the ore is expected to move towards the shorter-term index-based pricing.

After major buyouts and market share expansion, Vale , Rio Tinto and BHP Billiton ditched the traditional annual iron ore pricing for a quarterly contract but even this is seen as going by the wayside as these three aim towards spot.

“I think the quotation period will come closer to the market. I believe that an established market price is here to stay,” Jim Cochrane, chief commercial officer of Kazakh miner ENRC.

“I think that over time most prices will move towards a shorter-term pricing mechanism based on indices,” Cochrane said.

Coking coal, another takeover target by these 3 iron ore producers, is also seen moving away from annual contract pricing.

Obviously, this tendency towards spot pricing would make steel maker earnings less predictable and their stocks more volatile.