Iron Ore: Opportunity or slippery slope?

The significant volatility in the price of iron ore has recently captured the attention of our clients. This report aims to provide context and technical insights into recent trends in iron ore, alongside an analysis of some broader market factors at play.

Sector context

Iron ore is a crucial commodity globally, primarily underpinning the steel industry which is a cornerstone of the construction, transportation, and energy sectors. Australia plays a key role in this equation, providing around half of the global iron ore supply. On the other hand, China is the dominant importer purchasing about 70% of the global seaborne iron ore market. Key players in the iron ore sector include Fortescue Metals Group Ltd (FMG), BHP Group Ltd (BHP), and Rio Tinto Group (RIO). FMG focuses solely on iron ore mining, whereas RIO and BHP have diversified operations. All three are among the world's top iron ore producers.

Market dynamics and price influences

The iron ore market is generally balanced in supply and demand, which means that any shifts in pricing factors can significantly impact the commodity's price. The price has historically been largely influenced by China's demand, propelled by its ambitious growth targets, particularly in its infrastructure and property sectors. Recent trends show a decline in iron ore prices, affected by various factors including China's economic policies and global market conditions. In May 2021, the price peaked at nearly $230 USD per tonne, influenced by two main factors: supply constraints linked to Covid and China's robust government-backed infrastructure initiatives.

At the onset of 2024, iron ore was trading at close to $145 USD per tonne but has since dipped to 7-month lows around $100 USD per tonne, registering a roughly 24% decline year-to-date. While supply-side factors influence iron ore prices, they often reflect the state of China's economy. Despite the easing of some property policies in China, investments in the sector are dropping, and consumption is sluggish. However, China is committed to intensifying its stimulus efforts to boost its decelerating economic growth. There is an anticipation that a resurgence in infrastructure demand could potentially work to counterbalance the property market's frailty.

Source: Iron Ore (USD/T) tradingeconomics.com (20/03/2024)

Technical insights on FMG

FMG's stock price movements offer a window into the broader iron ore market's fluctuations. Recent trends have seen FMG's stock price experiencing volatility, influenced by iron ore price dynamics and broader market factors, making it a focal point for investors seeking to gauge the sector's health.

From a technical standpoint, FMG poses an interesting dilemma for investors. In response to the August 2023 lows in iron ore prices, FMG hit its own recent low in September at $19.28. Following that, FMG mirrored the iron ore price surge, rising by 50% in under four months to reach an all-time high of $29.50 in early February 2024. However, FMG's price trajectory has since declined, recently dropping below the 200-day moving average and rebounding from the 61.8% Fibonacci retracement level, which traces the movement from September's low to February's peak. The Relative Strength Index (RSI) indicated that the stock was in oversold territory when it dipped below 30 for the first time in 10 months. It has since experienced a slight rebound from these levels. Some investors may now be weighing whether the recent price and RSI bounce offers a buy signal and if the stock will maintain its position above the 61.8% Fibonacci retracement level. Additionally, the 200-day moving average could now act as a potential support level. Another aspect to monitor is the 50-day moving average descending towards the 100-day line, a movement that could suggest further downward momentum for the stock.

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Source: TradingView via CMC Invest Platform (19/03/2024)

From a fundamental perspective, the question remains: Will China's economic stimulus efforts sufficiently increase demand for iron ore, possibly triggering another price surge? The answer may largely revolve around China's capacity to rejuvenate its economy.

Additional factors to watch

The Chinese housing market warrants close attention, especially considering its impact on steel usage. Notably, in 2023 the property sector was responsible for approximately 30% of the steel demand in the country. China's housing market has shown vulnerability this year, marked by significant declines in property investment and sales. Specifically, property investment fell by 9.0% year-on-year, while property sales by floor area plummeted by 20.5% in the initial two months of the year. Additionally, new construction saw a sharp decline of 29.7%, and the funds raised by Chinese property developers decreased by 24.1% compared to the previous year. In response to these challenges in the housing market, China implemented its largest reduction in benchmark mortgage rates last month to bolster the real estate sector. Despite these measures, iron ore prices continued to fall, reflecting a weakening demand outlook influenced by China's economic conditions.

The US dollar is another critical factor in the iron ore equation, given its substantial influence on commodity price movements. The US Dollar Index (DXY) experienced some movement last week, influenced by the rise in the benchmark US 10-year treasury yield, which hit a three-week high at 4.31% last Friday. This increase contributed to a rally in the DXY. Analysing the daily chart, the US dollar index maintained its range within the Bollinger Bands (BB) indicator, with the price closing at 103.09 last Friday, just below the BB's middle line. Technically, the US dollar is trying to stabilise at the converging price level of the 50-day moving average (MA) and the middle-line BB, which is around 130.20, and it may aim for the next resistance level at 103.50. Investors should monitor this week's Federal Open Market Committee (FOMC) meeting closely; a dovish stance could result in the US dollar reverting to a downward trend, seeking support near the recent consolidated levels of 102.30 – 102.50.

One final factor for consideration is future trajectory of interest rates. Generally speaking, when interest rates rise, they can exert downward pressure on commodity prices, and vice versa. This is because changes in rates can affect factors such as holding costs, currency exchange rates, economic growth, and demand. Mixed signals are currently clouding the outlook for interest rates. Recent US economic activity indicates a slower growth with less-than-expected retails sales and a gently rising unemployment rate in first quarter. On the other side, the Producer Price Index (PPI) jumped up 1.6% year-on-year and the Consumer Price Index (CPI) was still sticky well above the 2% target. Investors will closely scrutinise Chair Jerome Powell’s March speech for any hints on whether the Federal Reserve will initiate a rate-cutting cycle starting in June. It's speculated that the Fed may eventually opt for two rate cuts by the end of this year.

Conclusion

Ultimately, while the recent drop in iron ore prices may seem appealing to investors, evaluating the underlying market factors is key. The future trajectory of companies like Fortescue will be impacted by several critical factors such as the state of the Chinese economy, the valuation of the US dollar, and interest rates. It's essential to remain cautious of the ongoing risk factors, particularly with China's influential presence continuing to loom large over the commodity's outlook.

Fraser Allan serves as the Head of Premium Client Services (Share Investing) at CMC, drawing on more than 12 years of industry experience. Applying his expertise in sales and private client relationship management, Fraser adeptly serves the needs of our premium clients within CMC Invest.