The Iron Ore Bust Will Get Much Worse

Loading of iron ore

After a few days rest for Easter, there’s quite a bit to talk about.

First up is the much worse than expected employment data out of the US. The non-farm payrolls report, released on Friday while markets around the world were closed, showed the US economy created just 126,000 jobs in March, which was half the level expected.

This could just be a one-off, or it could be the start of a weaker run for jobs. You won’t know for a few more months. But for now, the market likes it.


Because it pushes back the first increase in US interest rates to later in the year at the earliest. And who knows, if you see a run of weaker employment data, an increase will be off the table completely. By the end of the year, the geniuses that formulate policy will probably start talking about the need for more stimulus!

In its first trading session since last Thursday, the US market climbed 0.66%. That was partly to do with the poor employment data. But a strong bounce in the oil price in thin trading yesterday also helped the market along.

News that Saudi Arabia increased the price of oil shipments to Asia, as well as a more tempered view on when supply from Iran might impact the market, drove the price higher. This in turn saw oil related stocks rally.

Back in Australia, the price of iron ore continues to reach new lows. The benchmark price is now in the US$40s. On Friday, it hit US$47.08 per tonne, and with nothing but an avalanche of new supply on the horizon, the path of least resistance is down.

Look out for a counter-trend rally and calls of a bottom very soon though. The iron ore price has fallen around US$15/tonne in just the past few weeks. The bears are out in force now, and this is when you normally see a bounce.

If that does happen, don’t be seduced into buying iron ore stocks. The juniors will go out of business, Fortescue [ASX:FMG] probably wont survive in its current state, and BHP and RIO will see their profitability savaged.

Professor Ross Garnaut is the latest person to weigh in on the iron ore story. Garnaut is well connected in China owing to his three year stint as Australia’s Ambassador from 1985-88.

Writing in today’s Financial Review, Garnaut’s predictions make chilling reading for any iron ore producer:

Australia’s resources boom was a China boom. From 2007 to 2014, China accounted for more than the whole of the global increase in steel production. Chinese production rose from 489 million to 823 million tonnes. The rest of the world’s production fell from 855 million to 839 million tonnes. Chinese production will fall this year.

My Chinese friends from the 1980s include the technical and business leaders who in the past two decades guided the building in China of almost as much steel-making capacity as had accumulated in the rest of the world in the whole of industrial history. My old friends say that Chinese production should fall from a bit above 800 million tonnes today to about 600 million tonnes in 2030.

As Chinese economic growth matures, recycling of scrap becomes more important. Not for the foreseeable future in the proportions of the old industrial countries, but enough to lift steel production from scrap from 100 million tonnes a year in the recent past to several hundred million tonnes by 2030. So demand for the blast-furnace raw materials, iron ore and coking coal, will fall more rapidly than total steel production.

In case there is any confusion, let me spell this out succinctly: Australia is screwed.

If Garnaut is right, Chinese steel production will fall 25% over the next 15 years. Aussie iron ore companies, fooled by the false price signal of a manufactured Chinese credit boom, invested for demand of 1 billion plus tonnes by 2030.

On top of that, Garnaut reckons recycled scrap will knock out another 100 million tonnes of steel production.

This is nothing short of disastrous for the iron ore industry and Australia as a whole. In the mid-year budget update, released in September, the government budgeted for a US$60/tonne iron ore price for the next two years. At current prices, government revenues will fall by another $3 billion per year.

And if Garnaut’s prediction about steel production comes true, you’ll probably be looking at a long term price closer to US$30-40/tonne, wiping out nearly all the gains from the boom years.

In other words, the boom time revenues will be gone, but the boom time spending remains. You won’t be seeing a return to a budget surplus for a long, long time, folks.

Thankfully, Aussies are slowly starting to wake up to the fact that we do have a problem. In the past week or so, the mainstream media have been giving weight to the ideas you’ve been reading about in The Daily Reckoning for a long time.

That is, we need to see tax reform and pension reform and generally pull our heads out of our backsides and see what is really going on in this country.

While it’s good that we’re starting to talk about the issues, my fear is that vested interests still don’t see the bigger picture and will hijack the debate to suit their own ends. It will result in watered down reform that benefits a vocal minority at the expense of everyone else.

On top of that, any reform won’t kick in till after the next election, which is more than a year away.

What do we do in the meantime? I know, let’s cut interest rates, because it’s worked so well in the past!

And that’s exactly what you’ll see happen this afternoon as the Reserve Bank announces its interest rate decision. Markets are betting on another rate cut given the weak state of the economy and the poor prospects for employment.

The only thing that would stay the RBA’s hand today is concern about the risk of future financial instability from a bubbling housing market. But financial stability considerations come in well behind ‘inflation’ and employment for the RBA.

They will happily risk future financial stability to give the economy another few short-term jolts of monetary power. Apart from pressuring the currency, interest rate cuts are all but useless for the long term health of the Aussie economy now.

Household debt levels are already at record highs. There is no ‘pent up’ borrowing demand. All another cut to interest rates will do is reduce the income of savers and encourage even greater speculative behaviour in the housing market.

The sad thing is, it’s all we’ve got. The iron ore price boom has been and gone, and we’ve squandered it. The revenues have disappeared, but the promises made in the good times remain. We’re living on the credit card.

As I keep saying, it will take a real economic crisis to shake Australia from its state of ignorance.


Greg Canavan+,
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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slewie the pi-rat
slewie the pi-rat
1 year 6 months ago
“Thankfully, Aussies are slowly starting to wake up to the fact that we do have a problem. In the past week or so, the mainstream media have been giving weight to the ideas you’ve been reading about in The Daily Reckoning for a long time.” well! you guys really ARE screwed, then! Hahaha! actually, a little humility goes a long way when you’re talking about “governance”. and, it’s a good thing, too! Hahaha! ————————————————————– ‘FLATION Report! [for US Dollars, only] BLOOMBERG COMMODITY INDEX went up, nicely, today: 100.8 +1.3 [+1.29%] US DOLLAR INDEX: went down to: 97.02 [-0.51] commodities getting… Read more »
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