CBA: There's a worrying deviation in the iron ore market

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Chinese iron ore stockpiles are growing rapidly at present, as are prices. It’s an anomaly, and one that is concerning.

That’s the view of Vivek Dhar, a mining and energy commodity analyst at the Commonwealth Bank, who believes that it points to the likelihood of a correction in the iron ore price in the months ahead.

Here’s a chart, supplied by the Commonwealth Bank, that looks at Chinese iron ore port stockpiles, overlaid against the benchmark iron ore spot price from Metal Bulletin.

And here’s why Dhar is bearish on the medium-term prospects for iron ore prices.

The lift in iron ore inventories together with the lift in prices is unusual. Higher inventories normally tend to put pressure on prices. The deviation in this relationship over the last month is concerning too in that trade and production data suggest heightening surplus risks in iron ore markets. China’s iron ore imports have lifted by 9.0% y/y in 1H16, while crude steel production has slipped 1.1% y/y in the same period. On top of that, there is evidence in May and June that domestic Chinese iron ore production lifted due to the pick-up in prices.

Dhar believes that iron ore prices “drifted higher recently in response to stronger steel prices”, noting that the strength in latter was driven by flooding in Northern China and production cuts in Tangshan, a major steel producing region.

However, as these were temporary factors, it suggests that downside risks are building, says Dhar.

“As these temporary factors subside, we expect Chinese steel and iron ore prices to weaken in coming months,” he says. “We see iron ore prices returning to $US45/t (CFR China) in 2H16 as surplus risks mount.”

Year-to-date the spot price for benchmark 62% fines has risen over 40%, according to Metal Bulletin. If Dhar’s forecast turns out to be correct, it would represent a drop of 27% from its current level.

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