Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Fortescue Metals Group Ltd. has long been iron ore's greatest cheerleader, and with metal prices near the highest level in two years it's showing no sign of losing faith.

"You can see the confidence is back" among Chinese steel executives, David Liu, the miner's director of sales and marketing, said on an analyst call Tuesday. "The cheers of ganbei are getting louder and louder."

Those tempted to discount this as the sort of bullish talk you'd expect from a sales director should take a look at how China's steelmakers are doing from another angle: Blast furnaces in January were the second-most profitable they've been in at least seven years, according to estimates by Bloomberg Intelligence.

Iron Maiden
The estimated profitability of Chinese steel mills is heading to its second-highest level in at least seven years
Source: Bloomberg Intelligence
Note: Based on blast furnace-produced steel.

It's natural that when prices are running as hot as they are, traders start looking for reasons for a pullback.

What about port inventories, which rose to a record-high 113.95 million metric tons in December? Well, that apparent glut disappears when you consider it in relation to consumption, which has been growing equally fast.

Use It or Lose It
China's port inventories of iron ore don't look very high in relation to consumption
Source: Steelhome, China Customs General Administration, Bloomberg, Gadfly calculations
Note: Based on month-end inventories relative to that month's run-rate of consumption.

What then of the risks of a trade war with Donald Trump's administration? Also not a big worry for steel, which isn't much traded internationally and (in China, at least) is generally used as a prop for the domestic economy when external demand is looking weak. Japan's construction boom started almost immediately after the economy peaked in the late 1980s and didn't return to its previous levels for a decade.

Life After Death
Japan's construction boom went on for a decade after its GDP growth peaked
Source: Bloomberg
Note: Rebased. 1988 = 100.

Supply, another factor that concerns iron ore bears, also looks under control. Fortescue said Tuesday it will maintain shipments for the year through June at its previous forecast of 165 million to 170 million tons -- and as the big miners use current high prices to reduce their debts, the incentive to push supply that bit higher for the sake of the marginal dollar of cash starts to diminish.

The latest iron ore supply model from Bloomberg Intelligence sees about 139 million tons of additional supply entering the market by 2019, down from the 150 million tons forecast in June.

The advantage for miners is that there are so few of them that they're able to operate as an unofficial oligopoly, predicting the direction of the market by watching each other's behavior without any need for the sort of collusion that attracts the attention of antitrust regulators.

That doesn't mean iron ore prices won't fall from their current levels over the year ahead -- but at present we're at the low point of China's construction cycle, before building sites swing into action again in March. Those predicting that current prices of around $83 a ton are the peak should watch out.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net