The CBA says the iron ore price surge won't last -- this chart explains why

Kevin Frayer/Getty Images
  • Iron ore prices have been on a tear over the past couple of months, recovering after a sharp fall in November last year.
  • The Commonwealth Bank doesn’t expect the rally will last given subdued profit margins at Chinese steel mills.
  • It sees the benchmark iron ore price stabilising in the “high $US60 region this year”. It currently trades just shy of $US75.

Iron ore prices have been on a tear over the past couple of months, recovering after a sharp fall in November last year.

Gains in excess of 34% have been seen in some grades, underlining just how large the gains have been.

However, Vivek Dhar, Mining and Energy Commodities Analyst at the Commonwealth Bank, doesn’t expect the price surge to last.

He sees lower prices ahead, and the chart below explains why.

Commonwealth Bank

It shows the average Chinese steel mill profit margin going back to the start of 2014.

One thing stands out — while iron ore prices have been surging, profit margins have not, only increasing slightly over the same period.

To Dhar, that means gravity will soon reassert itself on iron ore prices, particularly for higher, more efficient and more costly, grades.

“We see low margins influencing iron ore prices in two phases,” he says.

“First, low margins will see steel mills prioritise affordability over productivity and emission reduction. That will see mills move to low grade ore, a trend that has already resulted in mid-grade and high-grade iron ore premiums falling.

“Second, low margins will discourage steel mills to produce, weighing on iron ore demand and prices.”

Dhar says the decline in margins has already resulted in steep falls in coking coal prices, another key steel-making ingredient.

“Premium coking coal prices have declined from around $US235 a tonne in early December to just under $US190 a tonne now. Meanwhile, iron ore prices have increased in that timeframe.”

Rather than a rebound in coking coal prices, Dhar says the most likely outcome is that iron ore prices will begin to track lower.

“Subdued steel margins will eventually mean weaker iron ore and coking coal prices as mills struggle to stay afloat,” he says.

“We expect iron ore prices to follow coking coal prices lower and stabilise in the high $US60 region this year.”

According to Metal Bulletin, the price for benchmark 62% iron ore fines fell 1.5% to $US74.78 a tonne on Tuesday, its largest fall in a month. It previously hit the highest level in two months on Monday.

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