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CBA: Get ready for a short-term rally in iron ore prices

Photo by Ezra Shaw/Getty Images

Iron ore markets woke from their slumber on Tuesday with spot and futures markets exploding higher, seemingly out of nowhere.

At 5.2%, the gain in the benchmark iron ore price was the largest in over four months, extending its gain from the lows struck earlier this month to nearly 12%.

It was a massive move but, as is usually the case with iron ore markets, there was no definitive explanation to explain the buying exuberance, meaning many are now pondering if the surge was a one-off or something that may be sustained.

Vivek Dhar, mining and energy commodities analyst at the Commonwealth Bank, is someone who watches the iron ore markets more than most. And, in his opinion, the move on Tuesday was driven by two factors — a speech from Chinese premier Li Keqiang and elevated margins for steel mills.

He explains:

Iron ore led mining commodity prices higher on demand hopes after Chinese Premier Li Keqiang said China maintained steady economic growth in the June quarter. He also indicated that China will be able to keep expanding at a “reasonable range”, which suggests that the economy is well on track to grow as planned at least 6.5% this year. The stronger rally in iron ore prices also reflected the scope of Chinese steel mills to purchase iron ore given existing margins.

But the question everyone is asking is, will it last?

Dhar has some good news for the iron ore bulls, at least in the short term.

“Elevated steel mill margins and abundant spare capacity should provide the impetus for a short-term rally in iron ore prices,” he says, adding that the main risk to this view is that Chinese steel mills may show a preference to use cheap scrap steel over iron ore in the period ahead.

While that suggests prices could rebound further short term, Dhar doesn’t think it will last for an extended period, forecasting that surplus pressures should see iron ore prices fall to $US45 a tonne by mid-2018.

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