CHART: Rising margins at Chinese steel mills helps explain why iron ore is in a bull market

Almost out of nowhere, iron ore is in a bull market, reversing the trend that saw prices tumble more than 40% from late-February to mid-June.

The sudden spurt of buying has surprised more than a few, leading many to question what exactly has been driving prices higher.

While a shortage of more efficient high-grade iron ore has been one factor underpinning the move, this chart below from the Commonwealth Bank also helps to explain why prices have been screeching higher.

Steel mill margins in China have soared as a result of higher steel prices and lower input costs such as coking coal and iron ore, encouraging mills to lift production levels.

Source: CBA

Vivek Dhar, mining and energy commodities analyst at the Commonwealth Bank, says this expansion in margins will likely continue to support iron ore prices in the short-term.

“The recent surge in iron ore prices reflects restocking demand, a shortage of medium and high grade ores and last, but not least, high steel mill margins,” he said in a note released today.

“We continue to see the iron ore rally gaining momentum in the short run as Chinese steel mill margins continue to remain elevated.”

Dhar notes that Chinese steel production has already lifted 5% year-on-year in the first five months of 2017, something he puts down to policymakers prioritising economic growth ahead of elections in the final quarter of the year, helping to underpin demand.

However, he, like many others, doesn’t expect that trend will continue into 2018 which, along with other factors, will likely weigh on iron ore prices.

“We still expect iron ore prices to decline to $US45 a tonne by mid-2018,” says Dhar. “Our forecast is driven by rising seaborne supply, Chinese steel demand eventually fading and increasing use of scrap over iron ore in steel production.”