Chinese Iron Spot Prices Hit Nosebleed Levels of US$110/ton

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 |  Includes: BHP, RIO, VALE
by: Erik Bethel

It was only 3 weeks ago I wrote about how iron ore spot prices had reached the breathless level of US$90/ton. Last week, the hysteria in the Chinese iron ore market reached a new decibel, with per ton spot prices surging to over US$110. We are skeptical of the price increases and think that sentiment is growing cautious. We forecast fewer deals in the market, in part, because the recent price hikes have been too fast and too high.

Much of China’s steel is being made from imported iron ore. In a nutshell, it is cheaper to mine for ore in Brazil or Australia and ship it to China than for Chinese steel mills to rely on domestic ore. The problem has been exacerbated as roughly 30-50% of China’s unprofitable domestic ore mines have been closed over the past few years. The end result is that today, China is the world’s largest importer of iron ore in the world, accounting for 50% of the market in 2008 and expected to reach 70% in 2009. China Customs and the Ministry of Transportation revealed that the country's main ports received 56.5 million tons of iron ore in July, 55 million tons of iron ore in June, and 57 million in May. In the first half of this year, iron ore imports surged 29% on an annualized basis to hit 297 million tons.

Chinese domestic steel prices have been booming this year, driven by strong demand from the real estate sector and the country’s US$580 billion stimulus package. However, Beijing has recently begun to significantly reign in commercial bank lending (which has disbursed an eye popping US$1 trillion from January-July 2009). This slowdown in bank lending will certainly dampen the recent real estate boom and with it, the demand for steel.

If there has been a clear winner over the past few months it is Brazil’s Vale SA. Iron ore price negotiations and shipments between China and Australia have slowed significantly since four of Rio Tinto's Shanghai staff were detained by China’s Public Security Bureau in early July. There has also increasing tension brewing between Beijing and Canberra at a diplomatic level. Vale has taken advantage of the situation and announced “new marketing policies,” including “more flexible pricing” that have allowed the company sell increasingly more iron to China. As testament to Vale’s (NYSE:VALE) better standing relative to Rio Tinto (RTP) and BHP Billiton (NYSE:BHP), ASXMarine notes that iron ore vessel bookings from Brazil to China increased to a record 39 in July, up from 24 in June. Meanwhile, vessel bookings from Australia’s main iron ore ports to China dropped to 31 in July, down from 40 in June. Vale’s stock is up 10% over the past three months while Rio Tinto’s is down 20%.

Over the past few months, the Chinese iron ore market has been on an interesting ride, to say the least. We’ve been watching the Chinese steel industry battle the Big Three iron ore companies, pitting the unstoppable force against the unmovable object. For now, the iron ore companies, particularly Vale, seem to be winning. But concerns are mounting that prices are moving beyond sustainable industry fundamentals and we foresee a market correction in the coming months. Stay tuned.