Traders should prepare for a 20 per cent surge in iron ore prices in the second quarter of 2023, according to Goldman Sachs, as the physical market swings into a “significant” deficit which will lift prices to a projected $US150 a tonne.
A seasonal boost in Chinese steel production in March-April is expected to coincide with a near-term supply squeeze, tipping the market into a 35 million tonne deficit in the second quarter.
While iron ore prices have already rallied 60 per cent from their October lows to $US125 a tonne, Goldman maintained its three-month target of $US150/tonne and its six-month target of $US135 a tonne.
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“Iron ore possesses one of the most supportive fundamental setups into the second quarter across the industrial metals,” said Nicholas Snowdon, metals strategist at Goldman.
The latest rally in iron ore prices has been largely fuelled by traders repositioning for China’s faster-than-expected economic reopening, but Goldman said it has also been reinforced by onshore supply tightness.
Indeed, since the start of the fourth quarter, onshore iron ore inventories have fallen by 45 million tonnes to sit at levels nearly 30 per cent below the same period last year. That marks the weakest since 2016.
This tightness in the spot market is compounded by what Goldman believes will be a large first-half deficit of 43 million tonnes, underpinned by a more acute imbalance in the second quarter.
However, the broker highlighted that this expected squeeze is being largely driven by seasonal patterns rather than a structural change in China’s steel-intensive property market.
While these conditions will support iron ore prices in the near term, Goldman does not see the rally extending into a prolonged bull market as was the case in 2021 when prices breached $US200 a tonne.
Chinese steel production is showing signs of improving ahead of the seasonally strong months of March and April, with onshore mills already ramping up blast furnace utilisation rates in February from January, Goldman noted.
Macquarie also observed in its latest steel survey that mills have lifted iron ore stocks, and plan to buy more raw materials in the near term, reflecting their expectations of higher steel output over the coming month.
“With steel demand appearing to be stabilising and likely to pick up further with the recovery of construction activity, while production growth could be constrained by weak margins, market fundamentals look to be improving for steel after months of weakness,” Macquarie analysts wrote.
Goldman added that Chinese steel mills are still suffering from extreme shortages following their destocking during the COVID-19-induced lockdowns, possessing just 18 days worth of iron ore coverage, the lowest since 2017.
“This offers a significant right tail skew to the onshore iron ore stock cycle this year, likely providing a powerful amplifier to near-term price upside as supply chain confidence stimulates restocking appetite,” Mr Snowdon said.
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Property pain
Goldman believes the main challenge for extending the iron ore bull market is the limitations for China’s property sector to rebound, given the sector generates close to a third of the nation’s steel and iron ore demand.
On the one hand, the broker anticipates a moderation of the deep contraction in China’s new property starts experienced over the last two years as stimulus lifts construction activity, and stabilises sales. However, Goldman’s credit strategists are still expecting default rates to remain high, further weakening the effectiveness of stimulus channels into property.
As a result of this liquidity crunch, and a move by policymakers to protect households over investors, Goldman expects cashflow to be diverted towards completions of current stock over new projects.
“While we expect property-related new starts demand to decline less precipitously, we do not see reopening as a regime shift in ferrous as we expect for the rest of the base metals complex,” Mr Snowdon said.
Goldman expects the iron ore rally to fizzle out in the second half of this year, with prices dropping to $US105 a tonne by the fourth quarter, and averaging $US90 a tonne next year.
Source: Australian Financial Review
