These 3 charts show the competing forces influencing iron ore prices

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Westpac has highlighted strong trading conditions in the Chinese steel market as the main catalyst behind the recent rise in iron ore prices.

As part of its report on the global macroeconomic outlook, Westpac’s research team looked at three key factors at play in the iron ore outlook for the second half of the year.

It’s been quite a roller coaster for iron ore prices in 2017. Spot prices for benchmark 62% fines reached $US94 a tonne in February before falling to $US53/t in mid-June.

Prices found support in the mid-$US50/t range before rallying back above $US70/t. Benchmark spot prices then fell for 2 straight days at the end of last week to settle at $US67.14/t.

While factoring in the improved operating conditions for steel production in China, Westpac also noted that the continuing buildup of iron ore inventories may prove to be a headwind for iron ore prices.

Westpac’s first chart shows a clear positive trend in steel prices, across both rebar and hot rolled markets:

The market has benefited from a crackdown by Chinese regulators, who enforced the closure of less efficient induction furnaces.

As research by Deutsche Bank showed in June, the remaining blast furnaces in operation have a preference for the higher grade ores, which includes benchmark 62% fines.

For the remaining Chinese steel producers, those higher prices are contributing to increased operating margins, with conditions now the best in 8 years:

That prompted Westpac to ask — “with Chinese steel profitability pushing to 8-year highs and Chinese steel production pushing to record highs in June, surely it is just a matter of time before port inventory was consumed?”

Not yet it would appear, as the third chart shows that iron ore port inventories remain elevated at historically high levels:

With Chinese iron ore supply still so high, the Westpac analysts are sceptical of the fundamentals behind the recent rally.

The research team suggested that the recent gains are also partly due to market speculation from traders.

Specifically, the raised the possibility that prices are gaining momentum as traders who took bearish bets on iron ore prices get squeezed out of their short positions.

Daily spot prices for benchmark 62% fines will be released later tonight, with movements in iron ore prices remaining of key importance to the profit lines of the big miners as well as Australia’s terms of trade.

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