Iron ore the sleeping giant wakes but what is next
Australian Market Strategist
Summary: The original sleeping giant, iron ore, continues to rise out of almost two year grave yard lows, and is up 40% from its November 2021 lows, and this week briefly touched a new 3-month high US$132.30. The rally to the new high was caused by, firstly China announcing or starting 3 trillion yuan, US$471 billion, in infrastructure projects, and secondly, Brazilian iron ore giant, Vale the world’s second largest iron ore producer, halted some iron ore production, representing 40% of Vale output, due to heavy rains. The news helped iron ore giant BHP on the ASX charge 4% yesterday and close at $46.85, a new 5 month high, while Rio Tinto also rose about 4% to $111.70, a new 4 month high. We look at what's next for iron ore and the mega iron ore giants, and what you need to know now.
Okay, overnight, the iron ore price gave back the day prior’s move and fell 2.4% on Thursday, taking the iron ore seaborne price back to US$128.14, as news came out that Brazil’s rain will ease, paving a way for mining to return to normal for Vale. So now...the iron ore price is knocking on a key technical level. So what’s ahead? Will iron ore’s rally continue and support the iron ore heavy weights stocks rebound?
Firstly - what is iron ore used for and why is it important
Iron ore is the key ingredient in steel. It is the world’s second most traded commodity behind crude oil. And is Australia’s largest export and contributes 5% to Australian GPD.
China is the world’s biggest buyer of iron ore, importing 70% of its iron ore needs. China is also the world’s biggest steel maker. China’s steel mills import iron ore from global miners such as BHP, Rio Tinto, Fortescue Meals, Vale and Anglo American. However China is working toward reaching carbon neutrality by 2060 and rapidly cut back steel production in July last 2021 to clear smog ahead of this years Winter Olympics (in Beijing, Feb 2022). That essential triggered the iron ore price to fall out of bed in July 2021 and fall 60% from US$214, to US$89.50 in November 2021. But since hitting that bottom, around November 23, iron ore slowly started to claw out of its bear market and gained 42% to where it is today.
Globally, so far this year and month to date, it’s really important to note, iron ore stocks and broad commodity stocks, have produced some of strongest gains, out of all the global themed stocks we track (for more please see our equity theme baskets).
Recent iron ore developments
On the positive side, what to note;
- China’s steel output is slowly improving but is still at low levels. Shipment leaving the Pilbara (Western Australia) are also increasing.
- Iron ore orders will be volatile but pick up again in March. So, ahead of the Luna new year holidays starting on January 31, orders are expected to pick up before slowing again. The holiday ends February 15, but China’s Winter Olympics will be underway then (starting February 4) and wrap up February 20. So after that, Beijing is likely to very slowly increase its bulk buying of iron ore again with China’s steel mills ramping up from March onwards. But this is a wait and see.
- Less than two weeks into 2022, China announced or kick-started 3 trillion yuan ($471 billion) of major infrastructure projects according to data from China’s provincial governments. That’s massive compared to the 1.2 trillion yuan in infrastructure projects announced from January 1-19 last year. That said, we’d need to see more stimulus announced from China to move iron ore up again. And I expect China will do that, as it wants to aggressively grow its economy (and infrastructure is key, with steel being needed).
- Morgan Stanley recently pointed out it has a short-term bullish view that steel production could grow 25% by 2Q22 versus the Oct-Nov levels. However, if China maintained its 4Q21 steel production in 2022, its full-year output would be down by the order of 15% year-on-year. And this would make the country's widely anticipated 5% GDP floor target pretty harder to achieve, given the continued importance of steel-intensive activities for China's economy
On the negative side, what to watch;
- China’s port inventories of iron ore are high, apparently just 10 million tonnes shy of the all-time high of 157mt in Mar-2018. Meaning China has a heck of a lot of idle iron ore, which is keeping the iron ore price from galloping ahead.
- China’s property sector is looking shaky and keeping gains in check. China’s biggest developers are in financial distress. Evergrande has recommenced work on over 60 major projects, but we still don’t know the fate of China’s property sector…if it will more of less collapse or continue on some sort of growth trajectory, supported by China’s bank cutting interest rates. In this regard, Morgan Stanley also notes softer full-year property demand will mostly be offset by modest growth in infrastructure investment (which Morgan Stanley expects to rise +6% in 2022), and machinery sales (to rise 3% yoy) and other end-market growth.
- China wants to reduce its reliance on imported iron ore, given it imports 70% of its iron ore needs. New mines in China are being commissioned and local governments are encouraging western miners to resume production after domestic output back peddled in 2021. Bloomberg estimates China’s iron ore output could rise 4.3% to 268 mt in 2022 vs a year earlier, after a 3.7% decline in 2021.
- West Africa’s Simandou iron ore deposit is said to be one of the biggest un tapped iron ore reserves and production is expected to come to the market, supplying 200 million tonnes. We will be looking for further clues as to when production might kick off as that could knock the top of iron ore’s rally.
Iron ore technical update
Saxo’s Technical Analyst Kim Cramer Larson pointed that iron ore has slowly been approaching resistance at around US$132.60. It is performing what looks like an ABC correction, which usually follows after a 5 wave move. A close above 132.60 is likely to extend the rebound to US$150-160. If rejected there is risk down to around US$108. If that scenario is to play out first warning could be RSI breaking below the rising trend line.
Stocks to watch
BHP- the biggest iron ore stock in the world
- The world’s biggest miner, and the biggest stock on the ASX, BHP is about to get bigger by market size, as it closes down its UK entity and unites the group on the ASX. BHP could rise from being 6% of the ASX200 to being 10% of the market. If shareholder and final court approvals go ahead, which BHP thinks should be smooth sailing, then on January 31 the S&P will change, and see BHP swell. For shareholders, going forward, after the unification, they can expect higher dividends and more buy backs. And imminently the dividends will be shored up as the group brings forward $6 billion of franking credits.
- But the biggest catalyst for BHP share price is a rise in the iron ore price. In 2021, BHP made 58% of its revenue from iron ore, 26% from Copper, 9% from coal and 7% from petroleum. BHP’s Coal and petrol revenue is being boosted by record prices, but remember that will reduce after BHP divests oil assets this year and in 15 months for coal.
- BHP sees iron ore demand picking up; supported by China ramping up stimulus and expects China’s GPD to grow 5.5% to 6% this year. So BHP will continue to focus on helping the world urbanise supplying iron ore, while also decarbonisation - supplying copper, nickel and potash.
- BHP’s shares are priced to perfection at these levels if you believe iron ore, copper, coal and petrol revenue will continue to rise. BHP shares gained 30% from November, after the iron ore price jumped 40% in that time.
- But can BHP get back to its August 2021 high of AUD$54? Some think so. There are currently 9 brokers saying BHP is a BUY. Much respected analyst, Glyn Lawcock from UBS, who now works at Barrenjoey has BHP as an Overweight position (a buy) and gave it a AUD$49.00 12 month target, while Macquarie rates BHP as an Outperform (buy) with a AUD$52.00 target. While much smaller broker Evans and Partners is the most bullish with a AUD$58.00 target. But beware of the bears. There is one research house that called BHP a sell, Morningstar, saying BHP will fall back to AUD$39.
Other stocks to watch
- Rio Tinto. RIO. Rio shares rocked up 20% from AUD$88.56 in November to where they are now. Can Rio get back to its AUD$135 high it hit in July 2021? The jury doesn’t think so, as Rio has been facing backlash about potentially building a $3 billion lithium mine in Serbia. Either way, tailwinds supporting Rio’s share price growth are from the way it’s currently generating revenue, right? But the market seems to have mispriced that, and is hanging a lot on the potential lithium mine. In 2021 56% of Rio’s revenue in 2021 was from iron ore, 23% from aluminum, 11% from copper and diamonds and 10% from energy, and all commodity prices are moving up.
Other heavyweight iron ore miners in production on the ASX include:
- Fortescue Metals. FMG is one of the world’s biggest iron ore producers. In 2021, Fortescue made 94% of revenue from iron ore. Most brokers have Fortescue Metals as a sell, expecting its shares to pair back by 20% in a year. The most bullish target out there for Fortescue, is $21.00. Barrenjoey rates FMG as a hold. Also note, only 15% brokers that cover Fortescue Metals (FMG) rate it as a BUY, but their price targets have already been reached.
- Mineral Resources. MIN is another heavyweight iron ore player. In 2021 65% of its revenue came from iron ore (after it exported 17.3 million wet metric tonnes of iron ore). Meanwhile it also exported 485 million metric tonnes of spodumene from its lithium project. 60% of brokers that cover Mineral Resources(MIN) are bulls and have MIN a buy, with Macquarie the most bullish with a $79 target. As for the bears, Morningstar has Mineral Resources as a sell with a $45.60 target.
- Champion Iron. CIA is a new comer to the iron ore block and rubs shoulders with the big miners. 100% of its income in 2021 was from iron ore. 14 broker houses cover Champion Iron (CIA) and all have CIA as a BUY - expecting an average 20% return in a year. To call out one, Macquarie thinks CIAs shares will grow to $7.40.
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