Iron ore has more upside than downside risk in the near-term: Macquarie

Macquarie has closed its bearish call on iron ore which was published back in August, when the investment bank warned about the risk of prices falling below US$90 a tonne.

"However, we stress that real signs of improving activity on the ground in China are needed for a sustained rally in ferrous markets to take place," Macquarie analysts said in a note on Tuesday.

"Lots of powder but no spark"

Last week's rumours about China's reopening led to a sharp rally in commodity prices, with iron ore rally back to the high US$80s after a brief slump below US$80.

"However, no clear policy adjustment has been announced and although the trend should be a move towards gradual re-opening, we remain cautious on China’s ability to ease its Covid policies ahead of the potentially large population migration during Chinese New Year," the analysts warned.

The near-term prospects for the steelmaking ingredient remain fragile, given the likelihood of new covid restrictions as covid cases in China approach levels not seen since April 2022, according to Macquarie.

"This presents a risk of a further hit to China’s construction activity, which has already slowed in October after the short-lived improvement seen in September."

A closer look at China

Steel margins in China have hit negative territory, which is forcing blast furnaces to reduce output, according to Macquarie. However, the level of iron ore inventory carried by steel mills remains low, so restocking will be needed at some point.

China's reopening was viewed as a potential near-term catalyst. However, more hard evidence is needed to show an improvement in all-important property sales and manufacturing sector.

Macquarie analysts observed a divergence between freefalling Chinese construction starts, down -38% year-to-date and more moderate declines in steel consumption, down just -2.9% year-to-date.

However, it was difficult to pin-point as to why this was the case. Are other sectors such as infrastructure and autos holding up? Or perhaps data is overstating the decline in new housing starts?

Source: Macquarie

Near-term outlook

All things considered, Macquarie analysts see more upside than downside risk on a three and six month basis.

"Iron ore was the commodity most impacted by China’s property downturn but should also be one of the commodities that benefit the most from a “China reopening” whenever this takes place," notes Macquarie.

"The longer the price spends trading into the cost curve and the more supply is trimmed, the greater the potential bounce back."