CBA: Chinese steel mills are making a motza, and that's been propelling iron ore prices higher

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Chinese steel demand is firm, prices are moving higher while the input costs to produce it have fallen, leading to a rapid improvement in margins at many Chinese steelmakers.

And, as a result, it’s helped to propel iron ore prices to levels not seen in close to three years.

That’s the view of Vivek Dhar, mining and energy commodities analyst at the Commonwealth Bank, who has supplied the following chart that shows the sharp improvement in Chinese steel mill margins as a result of higher steel prices and lower input costs, largely reflecting the unwind of the mammoth rally in coking coal prices seen in the second half of last year.

Source: CBA

“The pickup in iron ore prices can be attributed to stronger demand as Chinese steel margins expand, “says Dhar. “This margin expansion over the last few months reflects higher steel prices and lower coking coal costs.”

And, as Dhar suggests, as steel prices have lifted to the highest levels seen in over two years, that just happens to have corresponded with a similar lift in iron ore spot prices over the same period.

The two charts certainly look familiar.

Dhar says that steel demand has been the primary driver of higher steel prices, buoyed by an expectation among mills and traders that government-backed investment in infrastructure will be rolled out by policymakers to shore up economic growth before elections are held in November.

However, like his peers at Macquarie Bank, Dhar says that market participants are overly optimistic about the prospects for steel demand in the year ahead, laying the platform for an expected unwind in both steel and iron ore prices in the second half of the year.

“We continue to believe that markets are factoring in overly optimistic projections on Chinese steel consumption this year. Oversupply risks are increasing with evidence that China‚Äôs steel restocking cycle is nearly over,” he says.

“All in all, we expect iron ore prices to fall from current levels over the next six months, but prices may hold up at spot levels for a few weeks.”

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