Here's one of the biggest risks for iron ore prices in 2017

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Mirroring the price action seen in 2014 and 2015, iron ore prices have jumped out of the blocks following Golden Week holidays in China, gaining close to 4% over the past two days, according to pricing from Metal Bulletin.

It’s taken the gain for benchmark 62% fines to 32.5% so far this year, providing a largely unexpected windfall for beleaguered miners and investors alike.

Safe to say, sentiment towards Australia’s largest goods export by dollar value is now the highest that it’s been in many years, fueled by a seemingly unending infrastructure splurge in China.

While things are looking good right now, as those who have followed the iron ore market closely over recent years, soaring sentiment can sour quickly, particularly at this time of year.

A data print here or a policy change there, particularly in China, can change market dynamics in an instant.

So what should we expect for prices in the year ahead? Will the rebound of 2016 be sustained, or built upon, or is a correction on the way?

While no one really knows the answer, there are some factors to consider, particularly with sentiment sitting at elevated levels.

According to forecasts from Australia’s Department of Industry, Innovation and Science, after a modest lift this year, seaborne iron ore supply looks set to rise sharply in 2017, largely as a result of higher export volumes from Australia and Brazil, the two largest seaborne suppliers globally.

This chart from the Commonwealth Bank shows changes in seaborne iron ore supply, both looking back and in the year ahead. It’s broken down into supply from Australia and Brazil, along with other nations.

To Vivek Dhar, a mining and energy commodities analyst at the Commonwealth Bank, this “does not bode well for iron ore prices”.

“The main implication from Australia’s Department of Industry forecasts is that more incremental seaborne tonnes of iron ore are expected in 2017 than 2016,” he says.

“This view is consistent with guidance from the world’s major iron ore producers, who together account for ~80% of the seaborne market. These producers are expected to add ~75Mt next year, up from ~55Mt this year.”

While the increase in seaborne supply will likely displace other iron ore miners higher up the cost curve, something Dhar suggests is nothing new, the lift in supply, coming at a time when concerns over China’s residential property market are growing, could potentially place downward pressure on prices in the year ahead.

“The prospect of a larger iron ore supply impulse in 2017 relative to this year does not bode well for iron ore prices, particularly with the spectre of Chinese commodity demand fading next year,” he says.

“China’s property market, the biggest driver of commodity demand, may be on the verge of a downturn as policy makers try to curb property price growth once again.”

So that’s the downside risk to prices, but is there an upside risk as well?

Yes, there is, says Dhar. And it’s once again in the hands of Chinese policymakers.

“Iron ore price support is still not out of the question,” he says.

“If Chinese iron ore output (~20% of China’s iron ore requirement) continues to track lower, there is potential for iron ore prices to remain supported.”

Underlining this risk, he notes that Chinese output has fallen almost 7% in the first 8 months of the year, acknowledging that this “could fall more aggressively if the government aims to reduce loss-making production”.

That’s the great uncertainty, along with the outlook for Chinese steel demand — it’s largely controlled by policy decisions in China.

No one can say with any certainty as to what China will deliver, except the policymakers themselves.

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