UBS analysts Andreas Bokkenheuser, Janet Sun, Mick Mi, Tom Price, Daniel Morgan, and Rafael Cintra take a close look at iron ore prices.
Why aren’t iron ore prices rising; an update on seasonality While iron ore is supposed rise at the moment due to seasonality, credit constraints, supply growth and steel capacity shutdowns are weighing on the metal. More specifically, Xinhua News reports that 19 steel blast furnaces were closed and dismantled this month, while speculating that a third of China’s c200,000 steel traders could collapse due to tighter credit. Additionally, as 30-40% of current record high inventories appear to be part of financing deals, it leaves significant price downside once destocking commence.
Iron ore is not copper
Although the iron ore hypothecation trade is not new, it has picked up momentum recently on account of current credit constraints. But iron ore is not copper. As a bulk material there is a clear limitation of available inventory capacity at Chinese ports and steel mills, not to mention inventory degradation from unfavourable weather.
Possibly less than 12 weeks of restocking and price support left
According to our China steel team, port utilization currently stands at 60% (107mt), which assumes full capacity of 179mt. Assuming a cap of 80% utilization on average, we highlight there could be less than 12 weeks of restocking left (May), after which iron ore could come under severe pressure from material destocking. And with traders likely having repo’d inventories at an Fe62% equivalent price of US$120-130/t, we think a supply-driven H2 price correction could trigger panic selling, leaving substantial downside risk to prices.
VALE – value opportunity or value trap?
While our base case iron ore price assumes a >US$130/t price in Q2 followed by an average US$118/t in H2 (leading to a $15 price target and Neutral rating), we conclude that Vale Vale SA (NYSE:VALE) could trade down below US$10/share assuming an average US$100/t in 2015-16. As such, we reiterate our counter-consensus view that risk to Vale SA (NYSE:VALE)’s share price is to the downside, while highlighting our Sells on Usiminas and CSN. On a global basis, we prefer BHP Billiton Limited (NYSE:BHP) and Rio Tinto plc (NYSE:RIO).
