GOLDMAN SACHS: The iron ore rally is living on borrowed time

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It’s not unusual to see bearish iron ore forecasts right now. Increasing seaborne supply, along with slowing demand from China, has led numerous analysts to suggest the recent recovery in the iron ore price is unlikely to last.

In a research note released overnight, Goldman Sachs’ commodity researchers Christian Lelong and Amber Cai said the current rally is not only self-defeating but also “living on borrowed time”. They believe it is only encouraging marginal producers to add to supply which, according to their analysis, will have to close in the years ahead.

Here’s Lelong and Cai:

Chinese steel consumption is contracting and we expect seaborne iron ore demand to peak next year, turning the iron ore market into a zero-sum game. Our analysis indicates that mining productivity is currently improving by 4% per annum in Australia, resulting in higher output at lower cost; we expect other regions to experience a similar trend. Meanwhile, mining companies are still adding new mining capacity, with Roy Hill’s 55Mtpa due to be commissioned later this year and Vale’s even larger S11D project (90Mtpa) due to follow next year. Finally, some mines that had previously closed in response to lower prices are now reopening.

Although the return of Atlas Iron and African Minerals has company-specific drivers (e.g. new terms with mining contractors, a new ownership structure), the current rally has clearly provided some much-needed breathing space. In that respect, the current period of US$60+ prices is self-defeating because it merely increases the amount of mining capacity that will have to close over the period to 2018.

Based on their assessment the spot iron ore price will once again fall below $US50 a tonne over the medium term, in line with the current marginal cost of production in iron ore heavyweights Australia and Brazil.

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