Deutsche Bank says these 2 factors will drag iron ore prices lower in the second half of 2017

Photo: Sergei Gapon/ AFP/ Getty Images.

In a year where commodity prices made a spectacular comeback, few individual commodities surprised markets more than the rally seen in iron ore.

After years of declines, they jumped by close to 90%, helped by a combination of increased Chinese steel production, falling Chinese mine output and a flurry of speculative trading activity in Chinese futures markets.

And amidst signs of continued restocking, and optimism that Chinese policymakers will continue to roll out further large scale infrastructure projects to help bolster growth in the period ahead, the bullish price action seen in 2016 has continued into 2017, leaving the benchmark price for 62% fines near the highest levels seen in well over two years, according to pricing from Metal Bulletin.

After surprising so many for so long, there’s few signs as yet that the rally will roll over any time soon.

Grant Sporre and Michael Hsueh, research analysts at Deutsche Bank, share that view, suggesting that current elevated prices will be sustained in the months ahead.

However, beyond the short-term, they think that the price rally will run out of puff, suggesting that increased supply from both China and seaborne markets in the months ahead will likely weigh on prices in the second half of the year.

“Domestic iron ore production continues to respond to the higher price environment and is up 2.3% month on month in December. This means that iron ore output in raw tonnes is down 6% in 2016, much less than our 10% expected decline at the beginning of the year,” the pair wrote late last week.

The recent rebound in Chinese iron ore output can be clearly seen in the chart below, supplied by Deutsche Bank.

And, in unison with a lift in Chinese production as previously uneconomic mines come back online, Sporre and Hsueh suggest that Chinese import demand will continue to increase, adding further to supply.

“Our expectation is that iron ore imports continue to increase over 2017 in the region of 3-4%, but this is likely to be first half weighted with lower prices in the second half of 2017 weighing on domestic production and imports from the peripheral countries.”

As such, Deutsche, like others including the Australian Treasury, believe that this will eventually take its toll on prices.

“We remain steadfast in our view that whilst current price may hold for a quarter, the weight of latent capacity and new supply will drag prices lower in the second half.”

One suspects that the outlook for steel demand within China, along with the level of speculation allowed to persist in Chinese commodity futures, will also have a large bearing on whether or not that expected retracement in prices will arrive.

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