David Wang: Shares of iron ore and met coal miners have rallied recently, driven by increased optimism around Chinese demand for these commodities.
The most leveraged miners have more than doubled in price as iron ore prices have risen to $60 per tonne from $37 in December. We expect falling Chinese steel demand and increased Chinese scrap availability to cut iron ore prices in half. We think these miners are overvalued as a whole. The most leveraged ones have more than 50% downside, with this group including Anglo American (AAL), CSN, Fortescue, Teck Resources, and Vale.
While investors have accepted that Chinese steel demand has peaked, most continue to underestimate how far it will fall. Consensus sees Chinese steel demand stabilising around last year's 700 million tonnes, but we see continued declines to 630 million over the next decade due to faltering construction activity.
The threat of steel scrap availability is another factor that's not fully appreciated due to the long-term nature of the threat, but we think the impact will be significant. Leveraging academic work on steel product life cycles, we forecast scrap supply to more than double by 2025, with growth accelerating in the decades beyond as buildings and long-lived structures approach end of life. This drives greater production from electric arc furnaces and displaces iron ore and met coal demand.
Over the next 10 years, these factors should reduce China's iron ore demand by the size of total consumption of Japan, the world's second-largest consumer.
