China was the first country to experience the impact of COVID-19 and had the first economy to start to recover post the lockdown. Chinese stimulus proved to be more investment led than consumer led with a focus on government investments in areas like infrastructure. In contrast, countries like NZ and Australia saw a lot more direct consumer stimulus.
This resulted in Chinese steel production growing by 5.2% in 2020 whilst, according to the World Steel Association, the rest of the world fell 8.2%. The higher Chinese demand helped iron ore to grow from a healthy US$90/t at the start of the year to a super US$155/t by year end.
January 2021 saw a continuation of the economic recovery but as the Chinese New Year approached, there were new concerns that the authorities were tightening conditions. Several interest rates hikes were possibly designed to remind locals not to get too carried away with things like house prices. This caused the iron ore price to fall US$15/t in a few days from US$170/t before the market went quiet as the New Year holiday approached.
Iron Ore Prices and Chinese Steel Margins
Source: Macquarie Research
As a result, we feel the risk of meaningful near-term tightening is low. China has yet to fully recover the “lost” GDP from their lockdown in the first half of 2020 and they remain keen to see the recovery continue as their 14th Five Year Plan gets underway. That factor is particularly important as China always likes to have a strong start to these grand plans.
With new COVID-19 cases appearing, the Government restricted rail transportation with many workers not allowed to visit their rural homes. This means factories and other work sites should get back to normal quicker than usual in the Chinese New Year.
Consequently, our view is that iron ore prices will remain healthy in 2021, helped by little new supply coming on. With Chinese demand staying supportive and the rest of the world likely to produce more steel, we expect iron ore to stay north of US$100/t for most of the year. There are always risk to this playing out with tightening not being ruled out later in the year and with volatility assured.
The strong iron ore price should alleviate concerns that China will punish Australian iron ore exporters in the near term. Both countries dominate the seaborne iron ore market with China importing about 70% of the market and Australia exporting close to 60%. So, both countries need each other. We already see Chinese steel mills having to pay higher coking coal prices due to the ban on Australian coal putting them at a big disadvantage to other Asian mills. Paying more for iron ore will make things even worse for the Chinese steel industry.
Chinese Monetary Conditions and Steel Consumption
Source: Citi Research
2021 should prove a good year for Chinese steel demand and this means Australian iron ore miners should have another highly profitable year.
