This analyst warns weaker Chinese steel prices could send iron ore 'sharply lower'

Mandatory Credit: Craig Prentis /Allsport

Iron ore has been in the wars recently, losing close to 6% over the past four trading sessions, according to pricing from Metal Bulletin.

A stellar start to the year has suddenly turned sour with the current losing streak the longest since last October.

According to Vivek Dhar, Mining and Energy Commodities Analyst at the Commonwealth Bank, the recent price action could be a sign of things to come later in the year.

“We still anticipate iron ore prices to fall later this year on surplus concerns,” he said in a note released today.

“Chinese iron ore supply, which is the most expensive in the world due to its low grade, will be key to this outcome.”

Dhar notes that Chinese iron ore production rose 12% to 258 million tonnes last year, managing to overcome strict environmental protection checks and depleted resources from years of mining.

“Environmental protection checks particularly hurt private iron ore mine output in Shanxi, Shandong and Sichuan,” he says. “Without these restrictions, China’s iron ore output could have been as high as around 280 million tonnes last year.”

Even at 258 million tonnes, Dhar estimates that Chinese iron ore production accounted for around 20% of its iron ore needs.

Source: Commonwealth Bank

While Chinese supply is a wildcard for prices, Dhar says that falling steel prices, reducing steel mill margins, could present the biggest downside risk to iron ore prices later in the year.

“We still see steel margins dictating price action for iron ore once the steel output restrictions are lifted by mid-March,” he says.

“Steel mill margins have declined steeply on the back of falling steel prices in China.

“With steel margins contracting, iron ore markets could face a sharp price correction in coming months.”

With steel margins soaring over the past quarter, it helped to boost prices for iron ore and other key steel making ingredients, especially in higher grades due to environmental restrictions over winter.

“The restrictions have increased steel prices and boosted steel margins,” says Dhar, adding that it “has not only increased the incentive of steel mills not facing production cuts to increase output but has increased the amount that mills can spend on iron ore”.

If margins start to reduce, it could lead to lower levels of steel production, limiting demand for iron ore.

While Dhar sees the risk of a sharp price correction later in the year, near-term, he expects that recent price weakness will not be sustained.

“We expect iron ore prices to increase this quarter on stronger demand as the restrictions on steel production in China’s northern cities are lifted,” he says.

“The restrictions, which are in place to reduce air pollution, are largely expected to end by mid-March when the heating season concludes.”

Dhar adds that while the near-term trend is likely to be higher, “price volatility should be significant”.

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