Chinese traders are tipping iron ore will continue its dramatic crash to hit $US70 a tonne by the end of the year, as the spot price hit a fresh five-year low overnight.
But the private traders say local governments are keeping high-cost Chinese production alive, and less of it will fall out of the market than during the last great price correction, in 2012.
A trip by Morgan Stanley analysts to visit trading groups in China has thrown up some new intelligence on the near-term outlook for iron ore, with traders asserting that no iron ore traders are making money.
Spot iron ore is trading at about $US76 – a fresh five-year low – and a whopping 45 per cent down on the beginning of the year.
The price puts incredible pressure on Australia's junior producers – those outside the three Pilbara major – Rio Tinto, BHP Billiton and Fortescue Metals Group.
Morgan Stanley said this week that private iron ore traders in China expect oversupply will drive spot iron ore down further, to $US70 a tonne by the end of the year, and there is little upside to demand out of China. Iron ore financing in China also poses a big price risk.
Local governments in China are supporting domestic iron ore production by cutting taxes and therefore volumes will decline less than they did in 2012 – during the last great correction, Morgan Stanley wrote in a note to clients.
"They suggested iron ore financing is snowballing into a bigger problem, as steel mills roll over multiple letters of credit to pay for old ones and are forced to sell in the spot market to raise cash, which in turn puts more downward pressure on iron ore."
Currently, getting letters of credit from banks requires a 20-30 per cent deposit for players with good credit and 50 per cent to 70 per cent deposit for players with poor credit.
Liquidity conditions in the industry are worse than in 2013. Steel mills have just turned profitable recently and still have tight cash flow, while banks are more cautious on loans from commodities traders.
Morgan Stanley noted the key private trader they spoke to buys iron ore directly from BHP, Rio, and Cliffs and then sell to other mills.
"The company believes that no one is making money in iron ore trading right now, even Glencore, although the latter may be smarter in hedging," Morgan Stanley said.
The company does not believe $US80 a tonne is a support level for iron ore.
At $US80 a tonne, only small mines are shutting down, but large mines continue to operate and even expand and inventories in the market remain high.
Iron ore supply is not adjusting outside China, even with the price below $US80 a tonne, because miners need the cash flow and to maintain market share, even if loss-making, Morgan Stanley noted.
"It does not see upside to iron ore demand because mills are already running at high utilisation given currently attractive margins – steel companies have even postponed annual maintenance stoppages."
Other key takeaways included that China's domestic miners are cutting costs to below $US70 a tonne from $US80 a tonne by increasing efficiency, and are also helped by local governments cutting fees and taxes.
The traders said port inventory – which is 60 per cent owned by traders and 40 per cent owned by mills – has slightly retreated from the highest level of 115 million tonnes to 105 million tonnes.
