SGX Commodities Day reflects on iron ore outlook for 2023

All eyes on China in the global iron ore market

By Luke Jeffs

The SGX Commodities Day, held in London in November, asked a high-level panel of commodities experts to consider the state of the iron ore market in light of a slowing Chinese economy.

Hosted by Tan Tee Yong, director at SGX Group, the panel comprised Colin Hamilton, managing director and commodities analyst at BMO Capital Markets, Serafino Capoferri, a commodity strategist at Macquarie Global Markets, and Christopher Menzies, Strategist & Head of Business Development at Svelland Capital.

Tan cut to the chase, asking the panel of experts what were their thoughts on the current state of the Chinese property market, historically a massive consumer of iron ore.

Hamilton set the scene: “China is so important to the iron ore market overall. We have been having this discussion for the past ten years when will China’s steel production peak and when will we hit peak iron ore imports? We know the consumption per capita curve in any industrialising economy hits a peak and generally starts to trend lower. Realistically we are probably at that point.”

Property Market Shift in China

Hamilton continued: “We are starting to see a less steel intensive China over the past couple of years and on a go-forward basis. The shift away from a primary property market where you are building out new projects to a secondary property market where you are reselling properties is definitely starting to gather some traction.”

Data from China showed average new home prices in China’s 70 major cities dropped 1.6% year-on-year in October, compared to 1.5% lower a month earlier. October was the sixth consecutive month of lower new home prices, representing the fastest fall in prices since 2015.

Hamilton continued: “In terms of property, the numbers this year look horrible and a lot of the questions we get are around why are things holding up so well. I would highlight that that covers lot of the developers that are still under pressure and will remain under pressure.

“There is going to be a malaise among developers for a while but I would say in terms of overall construction, if you take into account factories, schools, hospitals and social housing, that’s not quite as bad. You are going to see a lot of investment into that which plays into President Xi’s prosperity agenda and you are going to see a lot of state-sponsored construction over the coming period.”

The feeling is that Chinese property development is shifting from residential to other types of buildings in line with the message from the China Party Congress in October that “housing is for living but not for speculation”.

Hamilton added: “That said, the China story is not over. You cannot simply go cold turkey on fixed asset investment overnight. In some economies people are worried about inflation but China is worried about deflation. If you think about a goods-based economy, we are seeing goods inflation peak and PPI is likely to be negative in the next print that we see.

“So we are still going to see some fiscal spending coming through and I expect to see more of that on things like manufacturing, particularly medium to long-dated loans there. China needs a productivity cycle to offset some worrying demographics.”

Peak Iron Ore

Hamilton concluded: “In our numbers, we are past peak iron ore imports – that was a couple of years ago – so we see that trend lower and we also expect China to generate more scrap over the coming years.”

Capoferri, a commodity strategist at Macquarie Global Markets, agreed with some of Hamilton’s points in offering a more nuanced perspective.

“Our view is a little more mixed in the sense that there is no question the level of government support is growing in China, we have seen that throughout Q3 though there is the complication of Covid. There is clarity around more support coming from the government.

He said: “From our perspective, you can‘t just think about China as China per se. If you think about the rally we have seen in commodity prices in the past two or three years, it is driven by goods consumption partly in the West which have had a heavy impact on Chinese exports. That has been the primary driver of Chinese industrial production.”

Capoferri concluded: “So, if you think about next year, you probably have a mixed bag, where you are going to have more support and a little bit of recovery in property, which can only get better from here.”

Citing the six months of weak data on new house prices, Capoferri added: “Even if you believe property has peaked, the contraction has been so sharp it’s pretty reasonably to think there is going to be a bounce.”

And Capoferri went on to reference an apparent disconnect between the weak data coming out of China and the country’s still relatively strong demand for steel.

Chinese Data Issue

“One point that Colin touched on that is very interesting and it is something that we have been struggling to make sense of, and our clients have been raising, is the disconnect between the end user numbers and the fact that apparent steel demand from the industry in terms of exports and inventories hasn’t been as bad.

“Maybe there is an element of the data not catching the extent of the construction activity but I do wonder also if maybe property isn’t as big as we think in China and manufacturing is consuming more than we think because that is the only way we could explain the disconnect and, if you believe that, the slowdown in imports is a concern.

Capoferri added: “We are starting to get more clarity and actually think the reported data on housing new starts fail to capture some parts of the Chinese construction industry. So we are now inclined to believe the YTD contraction in property has probably not been as sharp as implied by the data.”

Christopher Menzies is the Strategist & Head of Business Development at Svelland Capital, a commodities focused fundamental discretionary strategy that trades energy metals and the shipping markets.

Menzies described the trading strategy that Svelland has deployed to negotiate the current pressures in the iron ore market.

A "Recession Period"

He told the conference: “Ever since financial players deemed we were in this “recession period” of trading, the market immediately sold down a lot of the iron ore producers and some mining equities, irrespective of whether they were making money or not. But, if you look at the structure of the iron ore futures curve, it’s been pretty strong.

“The market traded in the $130s, $125, down to $100 and obviously we had that dip down in to $70s and a strong bounce back since. In our world, $100 iron ore is actually quite expensive and if you put that into the forward of some of these mining companies, you can in some names end up with a dividend yield of north of 20%."

Menzies continued: “So actually, some of these mining companies are doing pretty well in this market and, even if the iron ore price comes off, which it has a bit, those that have a robust framework around forward hedging have been doing pretty well.

SGX 62% Iron Ore Options

“As a result, we’ve been happy to be long some of the mining equities names, but we’ve been selling against that SGX 62% Iron ore options. Both legs of that spread have worked out quite nicely. The miners have performed pretty well, they’ve had good management and forward hedging, and we’ve been happy to collect the premium on the iron ore calls, which also provided some nice downside protection to the equities.”

Hamilton said the market is already adjusting to the prospect of lower demand from China.

“If we think about where we are, we are looking at Chinese steel demand down a little bit next year. If you look at all the big diversified miners, they are all now effectively using iron ore assets as cash cows to fund outside shareholder returns but also theoretically a pivot into future facing commodities. That is, they are not investing into the iron ore business.”

Hamilton said the “quasi-oligopolistic” nature of the iron ore production industry means some firms may opt to undertake what he calls “strategic maintenance” if iron ore drops to $80 a tonne.

He concluded: “It comes down to confidence in the Chinese economy, it will be interesting to see what the steel traders do as we head into that period where they normally build stocks ahead over Chinese new year. Are they confident enough to take more material on their books? That will play through to what the steel-makers want to do,” Hamilton told the conference.

The SGX Commodities Day was held in the Westin Hotel in London in November, and brought together some of the world’s top commodities traders, brokers and analysts, including SGX’s many commodities experts.

The presentations are being published in a series.

The first article covering the SGX Commodities Day in London is available here.

The second article in the series, featuring SGX's head of global sales Pol De Win, is available here

The third article includes an overview of SGX Commodities by the group's director Tan Tee Yong and is available here.