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Why China’s huge iron ore inventory at ports may not be negative

Low iron ore inventory played a critical role last year in pushing the Baltic Dry Index—a benchmark for the price of moving dry bulks across the ocean—to levels unseen in years before. In mid-2013, iron ore inventory at Chinese ports stood at just 70 million metric tonnes, below historic average. But as China imported record iron ore volumes, iron ore inventory zoomed higher. As of March 21, 2014, it stood at 103 million metric tonnes.

The importance of inventory

Investors can view rising inventory as a positive, in the sense that it reflects solid imports. But when inventory is high, it reflects possible over-purchases, which may prompt importers to cut back on imports in order to lighten up inventory in the near future. But when inventory levels are low, importers may restock, which will aid iron ore shipments.

Iron ore inventory at ports is now at 1.66 times February’s steel production. The ratio is often preferred over raw inventory figures because it measures how much inventory is available to keep current steel production activity going—if you have more kids to feed, you need more food stocked in your cupboard in the event of disaster. But note that February’s steel production was weak. So if we assume that steel production will grow faster over the next few months, the ratio might be lower.

Rising inventory

Rising inventory levels also suggest mills aren’t using as much as they’re importing. With the inventory level above the long-term average, this indicator by itself might suggest a negative for dry bulk shippers such as Navios Maritime Partners LP (NMM), Safe Bulkers Inc. (SB), and Knightsbridge Tankers Ltd. (VLCCF), and DryShips Inc. (DRYS), as well as the Guggenheim Shipping ETF (SEA).

Still, investors should look at this in conjunction with fundamental indicators such as steel production, the macro landscape, the Baltic Dry Index, and iron ore imports. Also note that if China doesn’t store a lot of domestic iron ore at ports, and if China’s domestic iron ore producers’ share of supply is shrinking, then higher iron ore port inventory over monthly steel production ratio is merited. So maybe it’s not as negative as you’d think.

Source: Market Realist