Iron's Jekyll-and-Hyde Moment Shows This Rally's `Dangerous'

  • Westpac’s Smirk says prices have advanced beyond fundamentals
  • ‘I think we’re actually in a Hyde environment,’ Smirk says

Iron ore’s latest rally has run beyond fundamentals and there’s a risk of a sharp reversal as prices tumble back below $50 a metric ton next year, according to Westpac Banking Corp. Senior Economist Justin Smirk, who says the raw material has something of a split nature.

“Most commodities are pretty Jekyll-and-Hyde,” Smirk said in an interview. “Iron ore does fit that trend. Hyde is meant to be angry, Jekyll is meant to lovely and nice,” he said, referring to the principal character in Robert Louis Stevenson’s 19th century classic who struggles with a dual personality.

The raw material has gyrated in the past three years, dropping below $40 in late 2015, soaring last year and enduring a switchback ride in 2017 as investors weighed the outlook for demand against rising mine supply. Since sinking toward $50 in June, iron ore has rebounded amid signs of sustained steel output in China, benefiting miners including BHP Billiton Ltd., Rio Tinto Group and Vale SA. That latest period of exuberance makes Smirk cautious.

“In that sense, we’re probably living in a strong Jekyll environment,” he said in Singapore on Tuesday, referring to the recent price gains. “For me personally, I think we’re actually in a Hyde environment because it’s over-optimism and speculation, and animal spirits at this point in time that are driving iron ore prices higher and above fundamentals. I find it dangerous.”

Spot ore with 62 percent content in Qingdao was at $70.43 a dry ton on Wednesday after gaining for five of the previous six weeks, according to Metal Bulletin Ltd. Although Smirk said the rally may go on for a while, and could test $80, he’s still expecting a drop back to about $40 in 2018.

While others including Capital Economics Ltd. also expect declines, principally driven by rising supplies, not everyone is bearish. BNP Paribas SA says iron ore is undervalued and prices should advance into the year-end, citing an in-house model that tracks China’s economy and currency.

Humming Along

At present, the earliest indicators show China’s economic engine is humming this summer, including a rebound in confidence at small- and medium-sized companies and improved sentiment at steel traders and producers. The country is the largest buyer of seaborne ore.

Smirk said he expects China to slow next year, and that steel production may start to drop off before that. After this fall’s 19th Party Congress, which will set the political hierarchy for the next five years, “it’s more likely to be tighter policy, more policies around reformation of the economy rather than policies geared toward growth,” he said.

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