CBA: Here's why the unbelievable iron ore rally won't last

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The spot iron ore price has enjoyed a stellar run of late. From mid-December the price has jumped by nearly 20%, leaving the commodity on the cusp of entering a technical bull market.

Helping to explain the sudden price recovery, China, the world’s largest consumer, has been busy replenishing stockpiles in recent weeks. In December iron ore imports to China ballooned to 96.27 million tonnes, the largest monthly total on record.

The increase, easily accounting for the previous record high of 86.83 million tonnes struck in January 2014, left annual iron ore imported volumes at 953.36 million tonnes, also the highest annual level on record.

Unsurprisingly, as import volumes surged, so too have stocks of iron ore sitting at Chinese ports.

The chart below, supplied by CBA’s mining and energy commodities analyst Vivek Dhar, tracks the level of Chinese port stockpiles to movements in the spot price.

As it demonstrates, just like the price, port stocks have soared of late, rising to 94.4 million tonnes last week according to data provided by Shanghai Steelhome.

Dhar suggests that the rebound is due to strong growth in low-cost iron ore supply from Australia and Brazil, along with a greater reluctance by steel mills to hold onto iron ore inventories as credit is tighter and losses accrue. „

While both stockpiles and prices have been moving in tandem of late, Dhar believes this phenomenon is unlikely to last, suggesting that the growing disconnect raises “the risk of a potential correction in iron ore prices in the short term”.

“We expect China’s raw materials consumption to remain weak this year, driven by an ongoing retrenchment in China’s property sector,” says Dhar.

“Already we have seen authorities announce plans to reduce China’s steel capacity by 100-150Mt by 2020. We see prices returning to US$40/t (CFR China) as surplus risks mount, unless the recent pick-up in China’s steel sector is maintained.”

According to estimates offered by the China Iron & Steel Association (CISA), China’s largest steel industry body, China’s State Council plans to cut crude steel capacity by 100-150 million tonnes by 2020, equating to around a 12.5% cut to China’s 1.2 billion tonnes of current crude steel capacity.

Dhar suggests the move reflects China’s intention to reduce loss-making behaviour and overcapacity in its industrial sectors as the economy transitions away from investment-led growth.

The slowdown in steel production, accompanied by a continued uplift in seaborne iron ore supply, slower-than-expected shutdown of high-cost Chinese iron ore production and growing threat of trade disputes rising from China exporting cheap steel product into international markets has many, including Dhar, predicting a continued slide in iron ore prices in the quarters ahead.

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