- NAB sees limited short-term upside for iron ore
- Coal prices also forecast to ease through 2012
- Commodity prices in general tipped to decline through 2012

By Chris Shaw

Following falls to what National Australia Bank saw as oversold levels in October, bulk commodity prices have partially recovered in recent weeks. The magnitude of the change in prices has been significant, NAB noting from a September peak the iron ore price declined by more than 35% to US$117 per tonne before subsequently rising by 25% over the following two weeks.

Prices have not fully bounced back to previous levels, something NAB suggests is a reflection of the market adjusting to an apparent slowdown in global demand and the increasingly uncertain global outlook.

In NAB's view this uncertain outlook means there is limited short-term upside for iron ore prices. Not helping is the lack of a clear growth outlook in China, as while activity indicators for October suggested a soft landing the outlook implied by forward indicators is far less certain.

Global steel production rose slightly in October, an uptick NAB notes followed four consecutive months of declines. Output remains well below the levels seen earlier this year. China remains the key, given steel production in that country is very important to bulk commodity markets given a heavy reliance on blast furnaces.

In NAB's view, the fall in Chinese steel production reflects a softening in the construction sector and high input costs squeezing profit margins. This margin pressure has eased slightly in recent weeks given the sharp decline in prices in October.

For some time NAB has taken the view ongoing strong demand from China would offset expected sluggish growth in Europe and the US, but market sentiment now appears less confident in such an outcome.

Longer-term fundamentals remain relatively positive, as industrial production and retail sales continue to grow at a reasonable pace in NAB's view. This suggests the recent slowing in fixed asset growth in China is not a major cause for concern at the current time.

As evidence of this NAB notes despite a series of policy tightening measures the level of residential investment in China has held up reasonably well. While the volume and value of transactions has been in decline in recent weeks, the ratio of residential building under construction to completions remains quite high. This implies the current rate of completions could last for a further five years.

Tight credit controls are causing some problems, as firms are increasingly finding it tough to obtain credit for projects. This could have implications for commodity markets in NAB's view, in part because it disrupts the ability of commodity importers to make payments on contracts but also because it threatens the viability of some investment projects.

These concerns have seen authorities start to take action to address these liquidity constraints, including the lowering of some reserve requirements on the back of indications inflation concerns may be easing.

For iron ore, a look through recent volatility shows despite the price falls last month apparent consumption in China remains at record highs. Most of the apparent consumption growth has come from domestic production increases, but falling ore grades and rising costs could mean mills will need to tap further into seaborne markets for supplies.

Lower seaborne prices have increased the incentive to purchase imported iron ore but with much of the Chinese restocking having already taken place, buyers appear content to sit on the sidelines at present. This leads NAB to suggest there will be little upward momentum in prices in coming weeks.

The recent drop in prices has sparked reports of Chinese buyers reneging on contracts to