Credit Suisse Iron Ore

Iron ore prices have increased significantly over the past few months, from a low of USD 117 in July8 to around USD 168 presently, with calendar 11 futures now trading at around USD 158. The price has moved higher despite a slump in global steel production around the middle of the year.

Despite recent increases, we expect prices to move higher over coming months,
approaching the highs seen in 2008 and earlier this year, before moving back toward marginal cost (around USD 150) later in the year. The move higher is likely to be supported by several factors:
1. While the level of global steel production remains subdued, the mid-year slump looks to have come to an end. Seasonally adjusted global production increased by 3½% in October, and we expect further solid growth over coming months. In particular, Chinese production looks set to rebound significantly over the first half of 2011, after falling nearly 15% between February and September (in part because of power restrictions). This is likely to see a significant increase in demand for seaborne iron ore over coming months.

2. The increase in the cost of production in India and China this year is likely to continue as the quality of domestic ore continues to decline, wages increase further and the renminbi continues to appreciate slowly. While it is difficult to be precise when assessing the state of the Chinese ore mining industry, it is likely that the Fe content being mined in China is continuing to fall, with the average reportedly down to around 30% and marginal mines as low as 12%9. This deterioration has combined with increasing wages to push up the cost of Chinese production significantly over recent years, with the marginal cost of production now reportedly as high as USD 150 per tonne for 62% Fe equivalent. Our best guess is that the average cost of the most marginal 100 million tonnes per year of Chinese production has increased to around USD 130 per tonne.

3. Indian exports are likely to remain weak for some time. While it is difficult to assess the likely duration of the Karnataka ban, we expect it to restrict exports for at least another couple of months, with the possibility that it remains in place for six months or even longer. In addition, while the ending of the monsoon should provide a boost to Indian exports, this rebound is a normal part of the seasonal process, suggesting that its impact on pricing should be relatively minor (historically prices have not exhibited strong seasonality). In addition, increased domestic demand and cost escalation are likely to continue to act as a break on exports.

While Australian and Brazilian exports should continue to grow solidly next year – after being essentially flat over the first half of 2010 – it is likely that the pace of growth will be below that in 2009 and below the rate of growth in steel production. We expect prices to average around USD 175 in Q1 of 2011, before easing modestly to around USD 140-150 in Q4. While we remain more bullish than the consensus of market analysts, our forecasts are broadly in line with current futures market pricing.