Commodity markets have surged through the end of November and into December on optimism that the rollout of vaccines could see global activity return to more normal levels. And with record amounts of central bank liquidity, ongoing enormous fiscal support and hopes that we will see increased investment into a ‘green recovery’ in the likes of Europe and the US have all added to the rising interest in industrials commodities.
Crude oil has jumped about $6 over the last 4 weeks or 13% with Brent crude pushing above $50 for the first time since March last night. Copper is also up 14% over the last month, above $7,800 a ton for the first time since March 2013.
However, its been iron ore that has really hit the headlines in the last few days, rising above $150 for the first time since Feb 2013. Importantly for Australian iron ore producers, in A$ terms it is now above $200 for the first time in 12yrs. The last time we had prices this high for the 62% benchmark iron ore index was August 2008.
So why are iron ore prices so strong?
Well, when looking at the drivers for commodity markets we have to look at both the supply and demand side. The very sharp recovery in China has in large part been driven by a boom in construction and infrastructure. And when you have a construction boom you need one key input. Steel. And lots of it.
Year to date China has produced 51mt more steel vs last year & 110mt more vs 2018. Its producing steel at an average rate of 3mt of steel per day for last 6m. Now 3m tons of steel is a staggering amount. Google tells me it took 52,000t of steel to produce the Sydney Harbour Bridge. 3mt per day is equivalent to 58 Harbour Bridges per day, 2.42 per hour or 1 every 25 mins.
To produce that much steel needs vast amounts of iron ore. About 60% of China’s iron ore comes from Australia and 20% from Brazil. However, supply from Australia and Brazil has not risen in line with a massive increase in Chinese demand.
Year to November Chinese imports of iron ore are 1.073bt – about 100mt more than the average over the same period in 2019 and 2018. Exports from combined Australia & Brazil are 1.101bt for the year to November – almost exactly unchanged from the average levels seen on average in 2019 and 2018.
Simple supply and demand mechanics would tell you that if the demand for a commodity from China has risen by 100mt while supply from the key providers is unchanged, price simply has to rise. And rise it certainly has.
Now not only has supply over the last year not met the rise in demand, expected supply has also taken a hit this last couple of weeks. After a very difficult couple of years given the Brucutu tailings catastrophe in 2019 and the hit to production from Covid in Brazil 2020, Vale had been expected to produce somewhere around 360mt of iron ore in 2021 as production rebounded.
Last week it gave guidance that production could be closer to 315 to 335, and effective cut of 35mt in expected supply next year. Expectations for Australian production may also be hit by the recommendations from an Australian parliamentary inquiry into Rio Tinto’s destruction of an ancient Aboriginal heritage site.
Of particular concern is the call for the re-audit of approvals under the so-called Section 18 of Western Australia’s Heritage Act. This act requires the consent of the Minister be sought where land users conclude that impact to a site is unavoidable. Rio has 6 section 18 applications pending approval and a large pipeline of replacement mines that may be impacted by a re-audit. Potentially impacting future supply from WA.
Now this jump in iron ore prices has certainly been a factor supporting the A$ this last week too. Indeed, other key commodities that Australia specialises in exporting are up sharply over the last 4 weeks as well.
Newcastle thermal coal is up 11% and Asian LNG prices up 14%. Bringing those moves together, over the last 4 weeks, the Westpac export weighted commodity price index has risen by 14%, and our short-term A$ fair value model has risen by just over 5%.
So, it’s hardly surprising that the A$ is the strongest currency in the G10 basket so far this month, hitting Bill Evans’ long held forecast of 0.75. And Bill is forecasting further strength next year too, with 0.78 by mid next year and 0.80 by the end.
Now this is our last markets update for 2020, and I would like to take this opportunity to thank all our viewers, our clients, families and friends around the world. 2020 has been full of challenge, loss and tragedy. I am really hopeful that the vaccine rollout that is now set to ramp up through 2021 with the FDA approval of the Pfizer AstraZeneca vaccine today US today will help bring a new normal and I hope that this brings opportunity to us all.
Event risk next week
Brexit talks to end (Sun), Japan Q4 Tankan business survey (Mon), RBA Dec meeting minutes, China Nov industrial production & retail sales (Tue), Eurozone flash Dec manufacturing and services PMIs, US Nov retail sales, Federal Reserve (FOMC) policy decision (Wed), Aust Nov labour force, NZ Q3 GDP, Bank of England policy decision (Thu), Bank of Japan policy decision, UK Nov retail sales (Fri)
