Iron ore had a spectacular first quarter, with prices rebounding to $63.70 per tonne from December’s low of $38.30, a 66.3-percent move.
The rally is a classic short-covering/restocking rally – a counter-trend move and possibly an accident waiting to happen. The fundamentals dictate that, with new low-cost iron ore coming on stream when demand is soft and there is a surplus of iron ore and steel, iron ore prices are likely to gravitate to the marginal cost of production, which is believed to be around $28 per tonne. With prices around $58, there is still plenty of room for them to fall once the restocking has run its course.
Overall trend – After the relentless downward trend in iron ore prices (see chart above), perhaps the market should not have been as surprised as it has been by the strong rebound. Restocking after the Chinese New Year, some optimism about a recovery in house prices in China, some pressure on holders of land-banks to build and a shift in speculators’ focus have all been reasons for the rally. Given the fundamentals, we see the rebound as a counter-trend move; unless there is a surprise and sustainable recovery in China’s economy, iron ore prices could easily retreat to test the lows around $38 per tonne again later in the year.
Iron ore seaborne supply to hold up in 2016 – Falling prices in recent years have led to production cuts, which are estimated to have pulled 230 million tonnes from the market. But the continuing ramp-up of new output should make up for any losses, keeping the seaborne market well supplied unless there is a sustainable recovery in demand, which seems unlikely. Weak global growth and China’s intent to cut excess capacity in the country, combined with anti-dumping measures against China, are likely to reduce its ability to export and in turn lead to lower domestic production. Less output may well mean less demand for seaborne iron ore.
New game in town – Speculating on iron ore futures seems to have taken off this year, with investors using the market as a call on how they see the health of China Inc. Average daily volume in the iron ore contracts on the Dalian exchange have increased to 3.48 million lots this year from 2.67 million lots in the fourth quarter and 1.95 million lots in the first three quarters of 2015. The increased speculation is no doubt partially responsible for how overbought iron ore prices have become. The danger is if marginal producers have taken advantage of the higher prices to hedge future production. If so, an already oversupplied market could become even more oversupplied, which would lower marginal production costs.
Source: fastmarkets