The Commonwealth Bank says these 3 factors are behind the sharp slump in iron ore prices

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Iron ore prices continue to unravel with the benchmark spot price for 62% fines slumping by over 3.5% on Monday, extending its decline over the past two months to over 30%.

As seen in the chart below, the speed and scale of the drop has been savage, leaving many to ponder just when the selloff will end.

While that’s now being debated, the broader question many are asking is why are prices, after soaring late last year, now reversing just as quick.

Is it due to the increased involvement of speculative investors in Chinese commodity futures, or is it being driven by more fundamental factors?

According to Vivek Dhar, mining and energy commodities analyst at the Commonwealth Bank, it’s the latter that’s driving the recent price action, and not just one factor but three.

Chinese steel output continues to lift despite falling prices, with crude steel output rising to a record-high last month. The sharp rise in coking coal prices has also squeezed Chinese steel mill margins, further reducing the appetite of mills to purchase iron ore.

Steel-market related weakness will continue to push iron ore demand lower. However, rising supply is also pushing iron ore markets into surplus. Most of the additional supply this year reflects committed projects ramping up output. A significant amount of supply though has also come online from more marginal sources. These additions reflect a response to higher iron ore prices through the March quarter.

So a combination of increased seaborne iron ore supply, a recent spike in coking coal prices as a result of supply disruptions in Queensland and ongoing strength in Chinese steel production despite recent price declines, fanning oversupply fears.

Not an unreasonable assessment by any stretch, and one that Dhar expects will continue to weigh on iron ore markets in the months ahead.

“We still expect iron ore prices to track lower to $US60 a tonne (CFR China) by the December quarter,” he says.

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