This page has been archived and commenting is disabled.
Goldman Declares The "End Of The Iron Age"
Back in the summer of 2008, when crude seemed poised to take out $150, Goldman decided to declare the start of a commodity supercycle and boosted its oil price forecast to $200. Shortly thereafter crude cratered, plunging to the low double digits, and causing many to scratch their heads whether Goldman was merely taking advantage of the pre-Lehman panic to sell into the euphoria. The same questions, but inverted, will likely follow today's just as seminal note, one which this time calls for the end of a supercycle, this time of iron, with "The end of the Iron Age."
While intuitively this makes sense considering iron ore prices have tumbled nearly 40% YTD and were at multi-year lows at last check with the demand picture going from bad to atrocious, the reality is that a protracted period of deflation in this key commodity will have very adverse implications for not only China, where CapEx amounts to over half of GDP and will likely force the transition to a consumer-driven economy - something the Politburo has been delaying for years - but for the rest of the commodity suppliers countries, with the most negative impact hitting Brazil and Australia. Worse, for a country like China which has thrived on commodity oversupply and overcapacity, the collapse in the equilibrium price driven largely by demand, will mean thousands of suppliers will be left out in the cold and forced to liquidate with massive ripple effects through the fabric of the Chinese economy.
To be sure, for the time being local governments, banks and other SOEs, and the central bank, have been successful in isolating the assorted pockets of deflation that has hammered China in the past several years, but if Goldman is correct and if indeed a iron (and other commodities) are shifting from the "Investment Phase" to the "Exploitation Phase" as Goldman calls it, then watch out below not only China, but the rest of the world as well.
So what exactly does Goldman say? Let's dig into their latest note:
The end of the Iron Age
Producers and investors have enjoyed a long period of supply tightness, cost inflation and above trend profitability; in our reports we have referred to this period as the Iron Age. In our view, 2014 is the inflection point where new production capacity finally catches up with demand growth, and profit margins begin their reversion to the historical mean; in other words, the end of the Iron Age is here.
Iron ore has entered a new exploitation phase
As we have previously argued3, a period of overinvestment in production capacity has ended, giving way to an exploitation phase where supply growth comes mainly from more efficient utilization of existing capacity. Production volumes grow with a certain time lag behind the investment decision; the lag in the mining industry between investment approval and production at full capacity is typically between 5 and 10 years. Based on historical trends, we believe that many market dynamics are reversed in the shift from investment to exploitation, and the current exploitation phase in iron ore could last for a decade (Exhibit 20).
On the demand side, lower prices for iron ore and steel are unlikely to boost demand in a material way. Instead, the day when steel production in China will peak gets ever closer. In the past decade, the Chinese economy added steel to its economy at a rate three times faster than the US did during the 20th century. On a per capita basis, the average household in China is accumulating steel at a rate equivalent to the purchase of a new car every 8 months (without disposing of its older cars). In other words, the volume of steel stock in China is racing towards the US level of 13 tonnes per person (Exhibit 21). If China is to converge towards the US level, steel consumption will eventually have to stabilize and steel recycling will play a larger role.
On the supply side, the capital stock of the iron ore industry in Australia, Brazil and China increased by US$180 billion during the period 2003-12; this will fuel production growth for years to come (Exhibit 22). Now that the market has transitioned to an exploitation phase we expect new approvals for capital intensive projects to become increasingly rare, largely because the economics of greenfield projects will be challenging in an oversupplied market. However, projects approved in the later stages of the investment phase will support production growth in the years ahead, and low cost brownfield expansions at Tier 1 producers will remain attractive.
Can prices recover once marginal supply is gone? We don’t think so
In principle, the displacement of marginal producers should eventually lead to a balanced market with a high level of concentration among the top 4 miners, raising the prospect of a price recovery further down the road. In practice, we believe that market fundamentals will continue to see supply growth outpacing demand growth by a ratio of 3 to 1 over our forecast period. Not only is the growth pipeline set to deliver several large projects over our forecast period (Minas Rio, Roy Hill, Serra Sul as well as large expansions at Rio Tinto and BHP Billiton), but the supply side will also have many idled mines waiting on the sidelines and ready to resume production should prices recover.
Moreover, iron ore markets went through a 20-year period of declining prices in real terms during the previous exploitation phase that ended in 2004. The iron ore price in 2003 was the same as in 1983 in nominal terms; this is equivalent to an annual deflation rate of 3% in real terms (Exhibit 23). In our view, iron ore prices will display a similar trend of cost deflation in the current exploitation phase.
Cost curves become flatter via the loss of marginal supply and they shift downwards via rising productivity and weaker commodity currencies. Commodity currencies have started to depreciate relative to the US dollar; the weighted average across five of the largest seaborne exporters has lost 16% since January 2011 (Exhibit 24). Given that a majority of production costs are denominated in local currency, this has a direct impact on the level of marginal production costs. On the productivity front, the increased focus on efficiency and the ramp-up of production has already resulted in a modest decline in unit costs among some producers; we expect this trend to continue.
Many moving parts but China remains the key question
The veil on Chinese iron ore production and the level of cost support it would provide to seaborne prices was supposed to be lifted as the market moved into surplus during 2014. But instead of a clear answer, recent data from China only raise further questions regarding the scale of the supply response low prices. In the seaborne market, the delivery of new projects in Australia and Brazil more than offsets the closure of marginal producers. Meanwhile, slower growth in low grade ore supply should see grade discounts normalise.
Chinese riddle: making sense of production statistics
The Chinese iron ore sector is highly fragmented and the data on supply trends is rather limited, but official statistics on price and volume have been roughly consistent in the past: high domestic prices coincided with growth in raw ore production, while market corrections in 2H 2012 triggered production cuts among marginal miners. On that basis, the recent decline in domestic concentrate prices should have led to another deceleration or even contraction in raw ore volumes. Instead, NBS statistics suggest that volume growth has accelerated (Exhibit 3). We find this highly counterintuitive. First, media reports from Platts and other sources indicate that many small mines stopped production from Q2 2014 onwards. Second, a rising volume of domestic ore would be inconsistent with the reported statistics on steel production and iron ore imports which show high growth in Fe supply but low growth in Fe consumption (Exhibit 4).
What does this all mean? We consider the following hypotheses:
- Official statistics do not reflect actual iron ore production. Provincial governments may set GDP or tax revenue targets at the start of the year, and set iron ore production estimates accordingly.
- Official statistics only capture some production. The smallest miners may slip through the cracks if they fall below the threshold used in data collection, preventing the closure of small private mines from appearing in official statistics.
- Production can cut at the concentrator rather than the mine. Mines may choose to suspend sales to concentrators but continue to operate in order to minimize disruption to their operations.
In our view, a combination of these factors could be responsible for the muddied picture, forcing us to look for alternative ways to assess current trends in Chinese iron ore supply. One option is to calculate the implied production of iron ore from statistics on crude steel production and iron ore imports. Taking into account the changes in iron ore inventory and the modest variations in the grade of imported ore, this analysis suggests that Chinese iron ore production on a 62% Fe basis grew during Q1 (partly reflecting limited disruption from a mild winter) before contracting in the following quarter; implied production in the year to July is down 11% yoy (Exhibits 5 and 6). Importantly, the timing of this contraction coincides neatly with the decline in the price of domestic concentrate in Hebei.
Industry sources also suggest that some Chinese supply has been displaced. The MySteel survey shows that utilization rates began to drop in May 2014 when the domestic price of concentrate was heading towards Rmb900/t, with the smallest mines reporting the lowest rates of utilization (Exhibit 7). Meanwhile, the consensus view at a recent conference on Chinese iron ore was that many private mines had indeed closed, even if the aggregate impact on production was limited due to their small size. However, producers also indicated that efforts to expand domestic production are ongoing, as implied by the volume of investment in the sector (Exhibit 8).
Given this wide range of sometimes conflicting indicators, we assume that future Chinese iron ore production would remain roughly stable before mine closures, as new projects and depletion at existing mines offset each other. We continue to assume that the average grade mined in China will remain stable at c. 20% Fe based on a) the reported grade of new projects and b) the fact that closures are likely to affect mines with below-average grades the most. After factoring in mine closures, we forecast domestic production to decline by c.9% per year on a Fe adjusted basis.
* * *
Over our forecast period, we expect input cost inflation to moderate as labour markets loosen and suppliers (from consumables to rail and port operators) see margin compression. The depreciation of key currencies including the A$ and the Brazilian real is likely to continue as weaker commodity prices weigh on the local economy. Finally, just as mining productivity began to improve among metallurgical coal producers during 2013, we now expect a similar type of improvement in the iron ore sector. On balance, we apply a 3% rate of annual deflation in real terms to derive our price forecasts for 2016-17 from our starting point of US$80/t in 2015.
»
- 16650 reads
- Printer-friendly version
- Send to friend
- advertisements -
http://www.planbeconomics.com/2014/09/limits-to-growth-was-right-new-res...
anyone who thinks they will make money following goldman recos deserves to lose their money. take a look at all the muppets they have slain over the years, anyone who falls for it at this point kinda deserves it. That said, i wouldn't bet against it either, even though it seems like a sure thing. Best just to stay away from it all together
The solution is simple..
Just make refrigerators and washing machines crappier than they already are so that they fail and are not worth fixing in 3 years rather than the present 7 years.. down from the 15 years of the 1990’s or the 20 years of the 1970’s.
You did remember a book:
The dictatorship of Cartels
Written in the early 1970s.
I read them all is happening today.
:-)
So steel is going to get cheaper? Good (I'll believe it when I see it, though). I use steel every day. I just won't invest in the steel industry.
"So steel is going to get cheaper?"
No, the "steel industry" is going to get squeezed....
Time to start the "off-world" metals index....
[Reptile dripping saliva and darting tongue.....]
Goldman Sacks, the tribe has spoken!
"Goldman Sacks, the tribe has spoken!"
Goldman Sacks, driver of the "Good Ship Lollipop" has spoken....
More Vaudeville!!!!
Each mine has its iron concentration, is like oil.
The file-mignhon ore is in Brazil - part of the BRICS.
Biased report.
Who gets screwed in this whole thing is Australia.
Brazil and China will exchange coal for iron ore using national currencies.
Another stone - this time mineral - about USD.
hehe.
You can look at everything coming out of TBTF and in the commodity markets as the USG and TBTF fighting to preserve the USD reserve, knowing that China and Russia have the gold and the other commodities... the real assets. All to benefit the .1%.
The golden rule still applies... we will probably learn a very hard lesson about financial sector hubris.
Golden years, go ooold, wah wah wah
-with apologies to Mr. Bowie.
So, Goldman wants to buy iron ore... By now, every long time ZH follower should be scratching their heads asking who wrote this babble. Did a new Tyler get on the desk and drop the script? Who on ZH wants an end to the commodity cycle? Haven't we been told gold is our savior in a world of Central Bank devils? When has this blog ever openly endorsed following The Squid's "advice"? GMAFB
Yeah, I'd like to take an iron - right upside Golem Ballsachs head(s)!!
I have always wondered how a 'FUGS'contrarian ETF' based on doing the EXACT OPPOSITE of the sell-side research broker notes that GS recommend would have done especially the last 5 years.
Iron or what?
Why do they think China hit peak iron? China is just getting started. India might be getting started to..... assuming their government stops trying to fuck up the economy.
Gold is only worth what it is not because it is rare, but because in ancient times was brought from afar.
Same goes for ivory, whale oil, Alaskan crabs, fish roe from Russia etc.
We'll have to go back in the past and find a balance in man / hours - without diapers - working to equate currencies.
I always think of a ton of cement, one ton of aluminum, a ton of vegetables and a ton of wheat to equalize things.
How much in man hours to reach that ton by country?
In coming up with an average, there will be the exchange value of these aforementioned goods.
Of course you can not calculate the right technology involved as 35 tons of a fighter plane for the same 35 tons of sugar from Cuba, but it has been done before.
It is unwise to try again, so before anyone died.
International exchange.
Below Petro-dollar!
And so the death of the Australian mining boom kicks into gear.We might make history.
"On the demand side, lower prices for iron ore and steel are unlikely to boost demand in a material way"
Since when do lower prices NOT increase demand?
zirp
So GM is negative on steel and gives reasons. Long steel then ?
the peak was already reached in 2012, if you paid attention to Chinese economics and Australian miners. The end of the China boom supercycle and peak iron was already certain fact to all but the deaf and blind in 2013.
but hey, it's always nice to reach an 'inflection point' in late 2014 and say 'yea, we saw it too', really...
Irony
WHAT! what did you say? the zion age is over? good! great news!
Funny how I found myself sharing GS mob´s opinions. China´s steel industry´s overcapacity equals 150% of Europe´s demand. Survival of some of the biggest companies is already a cliff hanger and disloyal Chinese have plans to start recycling scrap metal in a large scale. First in the hit list become West Australian marginal producers.
As the economy continues to contract, salvage operations will supply the lions share of metals for new construction. We will mine our land fills for what we need.
Wow!
That's really occult.
Goldman declaring the "End of the Iron Age".
Guess what? Occult philosophies describe four "ages", subdivisions of a cycle lasting approximately 26,000 years; The Age of Gold, the Age of Silver, the Age of Copper and the Age of Iron. Within this occult system of cycles, we began transitioning out of the the Age of Iron in 2012. We are now entering the Age of Gold.
This does not by any stretch mean that we are all going to become rich. It means that mankind has entered a transition stage. And transistion stages supposedly are usually pretty traumatic. The number of the Age of Iron is "7"; its sign is Death.
I'm quite ignorant about what you outlined, but its very interesting. I will do some further research. Thx for the details.!
Who takes advice from lying Banksters? Other lying Banksters, usually.
Must be why US Steel is up 3% today. Seriously how after knowing what we know about the squid can any of these people have a job. More over paid asshats who should be standing in a bread line.
I should know better than to respond to a zero hedge article since they are all basically the same in that they subscribe to Goldman's paradim of an extended China slowdown. Goldman developed this thesis based on Korea following the 1997 market collapse in which Asian countries had turned growth on the scale of 8.5 prior to the wreck of 97 and those GDP numbers on average moved down to 4.5 and remaind there.
Goldman also believes in the weakness of equity returns in emerging markets and claims the USA slower growth gives better returns.
What is really happening in ore. It is very simple
Google for chart RBA Statement on monetary policy August 2014 page 18 [zero would not publish my printed chart]
...
The cost of ore is everything. This is cost of ore delivered. To the left is Brazil ore which is VALE ore, Highest grade at 67% and lowest cost on the globe. Next in fashionalbe peach are the Australians. They are large aggresssive and their ore is good quality 62% and costs are contained. To the right we see the Chinese domestic ore. This is garbage ore at 55%, costs in exess of $100 ton. 30% of coastal mines have shut down.
Goldman thesis is that there will be no drop in capacity. There already has been a drop in capacity in China. Bank of China made it clear this year that they would no longer fund ore which had become part of the shadow banking fiasco. So the price of ore was a reflection of China's domestic ore not the Brazilian or Australian ore.
Total demand for ore and cement in china runs roughly 60% of the global demand. VALE supplies about 18% of this. That still leaves 40% of global ore going to other markets.
The Australians are teaching the Chinese a lesson in capitalism. When the price of or startd falling, Chinese reneged on their contracts preferring spot markets. Australians responded by cutting costs and increasing production knowing full well that this would kill Chinese domestic ore by making it a sinking ship. VALE was late to the dance but is now doing the same as the Austrailian majors.
Even if the majors sold all their ore exclusively to China they could not fill the demand. So the goldman notion that there is a glut in ore is simply unfounded and goldman NEVER supplies real numbers to support their thesis. They just gloss over it as they did with their Aluminum projections which proved wrong.
China is different than Korea and other emerging Asian markets. China is self funded. They can default all day long and just spread the disaster amongst 1.4 billion people. As one economist said, the profit off two tons of Chinese Steel is about as much as a lollipop. The long history of the Chinese worker is that they work long hard days for next to nothing. In America and Australia this would never work.
The Chinese however face the potental of domestic unrest. But once again the Asian mind is not a mind that seeks absolute freedom so don't expect rabid demonstration. The Gov of China will have to keep building.
It is true they have some vacant cities in the west but the major cities have a robust domestic economy including robust real estate market. Since most Chinese will eventually live in cities, the buildout continues.How is this funded?
In a word, EXPORTS. China is the greatest trading nation on earth. If you are a buyer of steel and can buy two tons of steel and pay a lollypop's worth of profit you'll buy it just at Americans buy Iphones.
Deflationary pressures noted in this article exist because China has tightened credit due to shadow banking and corruption in virtually all major industries. So they are willing to clamp down and allow deflation to cut back on speculation. Then what they do is target credit for certain sectors. I can assure you that they are not targeting the Chinese domestic ore business for loser credit.
Stockpiles of 100 tons which Goldman talks about incessently isn't leaving those ports because nobody knows which bank or banks own it. The shadow banking system saw each ton of ore used as collateral to as many as three differet banks. No wonder the price of ore was rising.
Goldman also cites pollution. This predomintely comes from cheap ore. VALE has green ore and high grade ore that requires less heat and gives off less products of combustion than the low grade ores. Green ore is a lot more expensive than the cheap stuff though Goldman never mentions any solutions, only problems.
Finally if one studies ore they would find that the commoditiy dollar average when compared to say coffee over time places iron ore at about 80 dollars a ton for the last sixty years or so. Thus the Goldman claim that ore to 79 is not exactly a bold call but likely wrong.
My own guess is that ore will follow Aluminum, a call that Goldman got wrong. I expect a drop in capacity of global or of about 200 tons even as VALE and the Australian Majors increase capacity. Australian majors are about done for now with capacity where as VALE, late to the dance can step up with 90 tons in 2016. Capacity comes slowly in iorn ore. This is a very capital intensive business and one where new sources of ore must replace old.
It is my opinion that the Australians have found the perfect medicine for China, a good solid dose of pure capitalism. Australians have been bold and now with VALE on board, an ore ologopoly is forming that will stabilize the price of ore and continue to blast away at China's domestic ore and shaddow banking. Chinese are concerned to say the least however Li of China visited Brazil with Iron and coal credits in hand and 7.5 billion in shipping credit. I am quite certain that China will continue to put the lid on Chinese domestic ore produciton and will learn the meaning of abiding perfomrance duties of contracts. The Australians are hard nosed and relentless capitalist. China has more than met its match with the Australians.
Best Wishes ZeroHedgers...