Should BHP, Rio Tinto and Fortescue investors be worried about the iron ore selloff?

2024 has been nothing short of a disappointing year for BHP (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue (ASX: FMG) investors – The three iron ore majors are down around 15-20% from year-to-date highs and trading at levels not seen since late 2023.

The weakness reflects a substantial downturn in iron ore prices, which fell a further 5% on Monday to US$108 a tonne. This marks a sharp turnaround from the almost 20% rise in the December quarter, fuelled by optimism for large economic stimulus measures from China. Analysts expected fresh stimulus and rate cuts to bolster the country's struggling real estate sector, which drives approximately 35% of Chinese steel demand.

Iron ore (blue) vs. Fortescue (red) performance in the past six months (Source: TradingView)

In recent weeks, China's economic data has flagged a sharp disconnect from expectations, including:

• 31 Dec 2023: Value of new home sales among 100 biggest real estate companies down 34.6% year-on-year (Bloomberg)

• 31 Jan 2024: Non-manufacturing PMI's construction sub-index stood at 53.9 in January, down from 56.9 in December. The weakness was attributed to "increase to low temperatures and the approaching Spring Festival holiday in China, which forced the construction sector to enter its off-season." (Xinhua)

• 29 Feb 2024: Top 100 developers' sales accelerated slide to 60% year-on-year in February following a 34.2% fall in January (Bloomberg)

• 11 Mar 2024: Stockpiles at Chinese ports are at the highest level in a year (Bloomberg)

Stimulus disappointment

The Monday selloff was largely attributed to the market's disappointment over China's policy support. Authorities seemed to favour new sectors like technology and renewables, leading to a lack of confidence among commodity bulls.

“China’s highest profile political event of the year provided little cheer for commodities bulls hoping for a jolt to demand in the world’s biggest market for raw materials,” Bloomberg reported on Monday. Instead, policymakers are making bets that growth from the old guard (real estate and infrastructure) can be replaced by new drivers of demand from sectors such as EVs, renewables and high-tech manufacturing.

The issue lies in the fact that iron ore rallied from August 2023 lows of around US$100 a tonne to peaks of US$140 a tonne on little fundamental support – Mostly on the back of stimulus hopes and peak interest rate expectations.

China seems to be growing more hesitant to dish out large stimulus to its struggling real estate sector. Coupled with soaring Chinese iron ore stockpiles, there might only be two appropriate words to describe the current price action for iron ore: Down and Volatile.

The Bloomberg article reported that “prices will have to drop further for inventories to be withdrawn,” Jinrui Futures Co. said in a note. The broker suggested building short positions in iron ore before Chinese steel demand picks up.

Data points to watch

Margins for Chinese blast furnaces have recovered back towards positive territory thanks to lower iron ore prices and domestic met coal pricing. "When China mills make a positive margin, volumes normally lift," says Citi.

China blast furnace rebar margins (Source: Citi)

China blast furnace hot-rolled coil steel margins (Source: Citi)

Port inventories of iron ore in China hit approximately 124 million tonnes from 114 million tonnes two weeks ago. Citi notes that a benign monsoon weather system in Brazil has seen Vale exports of iron ore rise 20% so far this year.

China port inventories of iron ore (Source: Citi)

Putting it all together: Iron ore prices have tumbled into deep oversold territory, driven by factors such as the absence of much-needed stimulus, rising port inventories and poor steelmaking margins. Iron ore prices could see a bounce from oversold levels but the economic data continues to point towards weak Chinese demand.