Iron prices have come back to ground, and give us a text book example of why boom and busts are such a regular feature of modern economic life.
The great iron reckoning is upon us.
And isn’t everyone freaking out about it. Woo boy.
You’ve got to feel sorry for WA Premier Colin Barnett (as much as you can feel sorry for any politician). He’s gone from riding the wave of endless revenues, to suddenly staring into a debt-pit deeper than one of BHPs mines.
And it’s all coming down on his head. There’s no passing the buck here. He was happy to have his signature all over the spending promises in the good times. Now he has to scrap those promises or put his signature on a seemingly endless line of credit.
If only he could have seen it coming some how.
But no, the whole iron ore community was taken completely off-guard.
Gina Rinehart was talking it up to shareholders and the mining industry last week:
“None of us predicted it would be as bad as this. Nobody was predicting – even the most conservative ones – the ore price crash.”
In a commodity market prone to booms and busts – all the time – no one thought that prices might come back to earth?
And the correction hasn’t even been that dramatic. Prices are still above long run averages and well above where they were when the whole mining boom took flight.
So we’re not even talking about a ‘crash’ in prices. Really, we’re talking about a ‘normalisation’.
That’s a big difference.
And the claim that nobody saw it coming..? There’s a lot of commodity bears out there. It would not have been difficult to find a dissenting view. Punch in ‘iron ore price crash’ into Google and you would have found a bunch of colourful opinions.
So is what she’s really saying is that no one on the inside of the industry saw it coming.
But again, that just seems difficult to believe.
Gina is a smart cookie, and she’s proved her mettle more than once in the business world.
(Gina has also become one of the most controversial figures of the century so far. Rigthly so. But if you’re looking for a space to critique her figure or fashion sense – without applying the same lens to Sam Walsh’s taste in suits or Clive Palmers stately paunch – take it elsewhere. It’s getting old.)
But for all Gina’s smarts, is she really asking us to believe that the iron price normalisation came totally out of the blue?
The dynamics behind the price normalisation aren’t complex.
In fact, it’s as basic as you get can it. It’s economics 101.
It’s supply and demand, pure and simple.
On the supply side, the industry just went a bit bananas. They poured billions into additional supply on the belief that the golden days of Chinese steel mills paying whatever it takes would roll on forever – no matter what collective supply response was brought into play.
But now that that supply is coming on line, there’s so much of it that Chinese steel mills can shop around.
‘I’m not paying $180 a tonne! I can get it for a third of that price on ebay.’
Over-supply is creating a fall in prices.
But even then it’s not really an ‘over’-supply, as such. This is just the market doing what it does.
If demand is stronger than expected (the sudden realisation of China’s appetite in 2007), prices go up. Higher prices bring more supply to the market. More supply puts downward pressure on prices. Prices normalise.
And this is exactly what’s happened. It’s vanilla market functioning.
And so really, no one in the mining industry thought that this was a possibility?
And that’s before you take into consideration the fact that almost all of your demand is coming out of single state-run economy. A sudden shift in demand must always have been a possibility.
But while I don’t really buy that no one saw it coming, I think it’s certainly true that no one was talking about it.
Because there was no incentive to. BHP, RIO and the boys were pumping the ‘endless Chinese demand’ story because it played well to their shareholders. Share prices increased.
Executive bonuses soared.
“Possible price normalisation” was just a story they didn’t want to hear.
And BHPs and Rio’s projections of demand (which were obviously from a biased source) quickly became accepted as fact. Analysts wove it into their narratives about valuations.
Governments built into their models of projected revenues.
And voices of reason were marginalised or ridiculed.
And the self-congratulatory euphoria has given us this. A $10 billion dollar mine bringing massive supply into an already saturated market where the super-sized profits have long since disappeared.
Gina’s Roy Hill will probably make money in the long run. But it will be nothing like the returns shareholders were promised.
If I was a shareholder I’d be pissed. But as Gina (and all of them) are saying, don’t blame me. It’s a shock to all of us.
Who would have imagined that the dynamics of supply and demand would have normalised prices?
Who could have thought?
This is why we have economic cycles in every asset class. People get excited. They start getting high on their own supply. But eventually, reality catches up with them.
And this is what creates timing opportunities. It’s why there’s money to be made being fearful when others are greedy, and greedy when others are fearful.
But you’ve got to keep your wits about you.