Why lithium stocks are soaring but iron ore majors are sinking on Wednesday

It's quite rare to witness two commodities, heavily reliant on China, moving in opposite directions on the same day. Pilbara Minerals (ASX: PLS) notably surged 4.6% at market open, whereas Fortescue (ASX: FMG) experienced a 2.2% decline, reaching a new six-week low.

When in doubt – Check Chinese futures

Chinese futures are my go-to data points for iron ore and lithium-related stocks (outside of company specific announcements).

Note: The below site is owned by Chinese multimedia company Sina. Everything is in Chinese but the numbers and charts will make sense.

• Lithium carbonate futures

• Iron ore futures

The important thing to note is that Chinese futures open at 12:00 pm AEDT and close at 8:00 pm AEDT.

If Chinese futures decide to rally after the Australian market has closed, then local stocks might have some catching up to do in the following session.

Chinese lithium futures were trading around 1.2% higher when the ASX closed on Tuesday. By 8:00 pm AEDT, futures finished 3.4% higher to 106,650 yuan a tonne or the highest level since 3 January 2024.

Morgan Stanley's positive take on lithium

Investment banks have been bashing lithium for over twelve months and for the most part – They've been right.

Morgan Stanley released a surprisingly positive note on lithium overnight. Here are some of the highlights:

• "We have learned that the Yichun government is requiring local lithium converters to: 1) Initiate self-inspection on environmental protection issues ahead of government inspections; 2)Track the direction of refining slags since late last year; and 3) Temporarily suspend transportation of refining slags across districts pending further classification of these refining slags."

  • For context: Refining slags are waste products generated during the process of refining lithium. They may contain various impurities, including residual lithium compounds, other metals, and potentially hazardous materials.

• "Some local lithium producers in Yichun ... have kept their operations suspended. The need for self-inspection may prolong these suspensions in the near term.

• "Overall, we think the current supply disruptions and concerns will lift near-term market sentiment as lithium output in Yichun accounted for around 20% of China's total lithium production and approximately 13% of global supply in 2023, according to SSM."

• "On the other hand, if the classification of refining slags is finalised, and no environmental protection-related issues are defined, we believe supply disruption will only be temporary."

Iron ore demand fails to live up to expectations

Iron ore prices have been trading between US$120 to US$140 a tonne for most of this year on hopes Chinese stimulus measures would revive economic activity and its beleaguered real estate sector. But local governments have so far been reluctant to release the flood gates.

The data from Mysteel points to a rather bearish outlook for the steel making ingredient. Here are some of the key takeaways from its report dated February 26.

• Iron ore demand among most Chinese steelmakers after the Lunar New Year as weakness in imported iron ore prices made mills opt to monitor prices first instead of restocking immediately

• Steel mills are facing poor margins or even losses, many steelmakers postponed plans to resume production and others started idling their blast furnaces

• Hot metal production among 247 Chinese steelmakers ended six successive weeks of gains over February 16-22, down 0.5% week-on-week. Industry sources expect the fall in output to continue this week

• Iron ore port stocks have accumulated to an 11-month high

Fortescue shares are down around 10% since late January (the stock also traded ex-dividend on 28 February).

Fortescue daily price chart (Source: TradingView)

A closer look at Pilbara

Pilbara Minerals is poking its head above the key $4.00 level to levels not seen since October 2023.

Pilbara Minerals daily chart (Source: TradingView)

The stock's 21.2% short interest makes it pretty tricky to know what's going on. What I mean by that is:

• Is the stock experiencing genuine and persistent short covering?

• Are short investors only covering a little into recent share price strength?

• Will short investors reload given the uncertainties regarding lithium prices?

• Is Pilbara rising more because of short covering (so its share price strength is somewhat artificial and short sellers are the ones pushing the share price higher as opposed to genuine buyers)?

The stock hit a brief session high of +7.7% or $4.18 on Wednesday but eased to +4.9% or $4.07 at 11:20 am AEDT. Citi released a note this morning downgrading the stock to SELL from Neutral with a $3.60 target price.

"PLS is up 10% over the past month ... After the rally we downgrade our recommendation from Neutral to SELL. PLS is trading in a spodumene price over US$1,600 a tonne vs. spot of US$800-900 a tonne," the analysts said.