Iron Ore Price Will Halve

Falling Chinese steel demand and increased Chinese scrap availability will cut iron ore prices in half says Morningstar analyst David Wang

Morningstar Equity Analysts 26 April, 2016 | 10:49AM
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David Wang: Shares of iron ore and met coal miners have rallied recently, driven by increased optimism around Chinese demand for these commodities.

The most leveraged miners have more than doubled in price as iron ore prices have risen to $60 per tonne from $37 in December. We expect falling Chinese steel demand and increased Chinese scrap availability to cut iron ore prices in half. We think these miners are overvalued as a whole. The most leveraged ones have more than 50% downside, with this group including Anglo American (AAL), CSN, Fortescue, Teck Resources, and Vale.

While investors have accepted that Chinese steel demand has peaked, most continue to underestimate how far it will fall. Consensus sees Chinese steel demand stabilising around last year's 700 million tonnes, but we see continued declines to 630 million over the next decade due to faltering construction activity.

The threat of steel scrap availability is another factor that's not fully appreciated due to the long-term nature of the threat, but we think the impact will be significant. Leveraging academic work on steel product life cycles, we forecast scrap supply to more than double by 2025, with growth accelerating in the decades beyond as buildings and long-lived structures approach end of life. This drives greater production from electric arc furnaces and displaces iron ore and met coal demand.

Over the next 10 years, these factors should reduce China's iron ore demand by the size of total consumption of Japan, the world's second-largest consumer.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.