It looks like steel's golden run is coming to an end -- iron ore and coking coal prices could be next

Photo by China Photos / Getty Images.

After years of steep price declines, weighed down by a slow in Chinese construction and acute overcapacity across the sector globally, steel prices have enjoyed a strong run of late, jumping strongly from the depths seen earlier this year.

A sudden rush of activity in Chinese infrastructure and residential construction at a time when inventory levels were extremely low, along with the promise from Chinese policymakers to shut down uneconomic steel capacity within the nation — the largest steel producer globally — has proven to be a potent mix.

Along with a rush of speculative buying in Chinese futures markets, prices have soared, dragging the price of iron ore and coking coal with it. Profitability at steel producers, along with many bulk commodity producers, also went along for the ride.

According to analysis from the National Australia Bank, profitability at Chinese steel mills hit their highest levels since 2009 earlier this year, taking it back to levels last seen during China’s unprecedented infrastructure stimulus spend, implemented to ward off the effects of the global financial crisis.

The chart below from the NAB shows the steep and sudden gain in steel prices from earlier in 2016.

However, the boom times for the beleaguered sector may be coming to an end. Steel prices are turning lower and there’s tentative evidence that prices for its raw ingredients are also doing the same.

As Bloomberg noted earlier today, while many steelmakers surprised analysts with better profits and the stocks enjoyed the best rally in years, the industry’s biggest problem hasn’t been solved: crippling overcapacity in the sector, particularly in China.

“We don’t think at this point that the recovery is sustainable,” Alon Olsha, an analyst at Macquarie Group in London, told Bloomberg. “There remains a huge amount of overcapacity in steel and latent capacity that can easily be turned back on.”

Moody’s Investor Services agrees with the sentiment expressed by Macquarie, suggesting that market conditions are likely to remain challenging in the second half of the year with “uncertainties around prices and level of imports from Asia”. The group also warned that the coming months “should see mounting pressure on prices in all regions”.

Vivek Dhar, a mining and energy commodities analyst at the Commonwealth Bank, also shares this view, writing in June that the recent acceleration in steel production levels, boosted by a surge in Chinese residential construction, was unlikely to last.

“Higher inventories in lower tier cities will likely remain a problem for China’s property sector, not only weighing on commodity demand at some point, but boosting concerns that the recent price uptick is more speculative than fundamental,” he said.

“With China’s stimulus measures likely to fade later this year, we think construction demand will weaken by 4Q16.”

Given the downbeat view for the sector, along with the recent slide in steel prices, it appears that risks for both iron ore and coking coal prices are now building to the downside.

Earlier this week, propelled higher by speculative buying following a series of reports in Chinese state-run media surrounding previously announced production cuts in China’s coal and steel industries, Chinese coking coal and iron ore futures both jumped to multi-year highs.

That, in turn, drove strong gains in spot prices.

Just how long this can last, presuming that the recent trend in steel prices continues, is debatable.

“We expect Chinese steel and iron ore prices to weaken in coming months,” said Dhar last week. “We see iron ore prices returning to $US45/t (CFR China) in 2H16 as surplus risks mount.”

You can read more here.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.