MACQUARIE: The iron ore price drop isn't over yet

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The recent decline in iron ore has been well documented, and analysts at Macquarie think it has further to go.

Strong demand and a healthy dose of speculation combined to drive benchmark iron ore prices over $90 per tonne on February 21.

The subsequent fall has been impressive in both its speed and scope, with prices crashing 31.9% in the last two months.

A small increase this morning left the price for benchmark 62% fines at $64.60 per tonne. In Macquarie’s view, that still isn’t an accurate reflection of market fundamentals.

The bank expects to see iron ore find support at around $50 per tonne, suggesting that falls of a further 20% are in store.

Macquarie analysts note that “as per any other classic pricing cycle, supply has responded to high prices and margin incentives and ultimately overwhelmed demand, while restocking has come to an end”.

That scramble to meet demand is reflected in China’s most recent trade data, with yearly iron ore imports up 12.2% in the first quarter of 2017.

Furthermore, data to the middle of April shows that domestic iron ore mining production in China has also risen to its highest level since October 2014.

“With iron ore prices having rolled over, port inventories have also peaked, as traders, who were happy to sit on inventory when prices were rising, have now started to sell more aggressively,” Macquarie said.

The bank notes that mill inventory is also still above average, “which will exacerbate the weakness and potentially result in prices overshooting to the downside before mills return to replenish inventory again”.

As a key component of steel, iron ore has also suffered from weakening steel prices. In addition to increased steel production, Macquarie cited weakness in steel demand, with the bank’s analysts casting some doubt as to veracity of recent Chinese data.

“The decline in steel exports, meanwhile, means that 1Q17 apparent steel consumption was up just more than 10% YoY,” Macquarie said.

“We believe real demand growth is likely running at a level below half of that, which means there is a clear oversupply in steel domestically, and we would expect to see Chinese steel prices continue to fall until they reach a level at which steel mills can once again look to the export market as an outlet for the oversupply in the domestic market.”

Macquarie doesn’t expect sharp falls in steel demand in the near-term, as Q2 is generally when the Chinese construction cycle peaks.

“For iron ore, however, we still believe prices should be back at a fundamentally supported $50 per tonne level per our 2016 forecasts, and thus we still see potentially at least another 20% downside to prices from current levels to start pressuring some of the marginal supply that has recently reappeared to again exit the market.”

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