Cleartrade Exchange Pte : Can Iron Ore Continue to Depend on China?

19 January 2017
,

As one of the best performing commodities in 2016, spot iron ore prices soared more than 85 percent year-on-year to a two-year high. The unexpected jump in prices was not entirely supported by fundamentals and most analysts believed since mid-2016 that the commodity would fall once reality sinks in. Surprisingly for the market, the uplift lasted through the year and has continued in the early weeks of the New Year. The rally in prices was mainly driven by China's demand for imported iron ore as well as speculation on Chinese exchanges.

The Chinese government's decision to reduce domestic steel production is one of the reasons for the upswing in prices. Throughout the year, the government ordered steel mills to stop or reduce operations in a bid to clear up air pollution and ease the global steel overcapacity issue. Since steel production was expected to decline, prices were strong and thus boost the prices of its key ingredients, iron ore and coking coal.

As the government is pushing for the use of higher quality iron ore, imported iron ore, especially from Brazil and Australia, was expected to increase. This resulted in the stronger iron ore prices. According to China's Customs General Administration,imported iron ore in December fell from the previous month and year, but the total amount of iron ore imports into China surged to a record high of 1.024 billion tonnes, passing the billion tonnes mark for the first time.This further supports the fact that Chinese demand for iron ore is still growing, though at a slower rate.

High levels of speculative trading in the Chinese futures market resulted in a surge in steel, iron ore and coking coal prices. The Chinese government and regulators had to step in to clamp down on speculative activity, by raising transaction fees and margins. The total daily iron ore volume traded on the Chinese exchange exceeded the total annual physical consumption, reflecting the degree of speculation going on in the iron ore market, which could potentially result in a sharp drop in iron ore prices.

Also crucial for the iron ore market is the property market in China as it consumes a large portion of iron ore for its development. Based on a Reuters poll of 62 economists, China's economy growth is expected to remain steady at 6.7 percent in the last quarter of 2016, unchanged from the previous 3 quarters. The improvement in the property market is certainly one of the drivers behind the high iron ore demand in 2016. However, with the Chinese government's policy to control the rising property prices and thus reduce construction, it is likely that iron ore demand will be adversely affected.

While the increase in imports could imply an improvement in demand for iron ore, stockpiles in its major ports have also built to a record figure of 118.15 million tonnes in the week ending 13 January, according to data by Shanghai Steelhome Information Technology Co. This has raised concerns over the consumption of iron ore in China. However, the rise in iron ore stockpiles could also be due to restocking by steel mills ahead of the coming Lunar New Year holiday.

Additionally, iron ore supply from both Australian and Brazilian miners are expected to increase as they show no intention of rebalancing the market, though they did lower their production guidance slightly. Brazil's Vale has also started iron ore shipments from its S11D project, which will help increase iron ore supply in 2017. The surge in iron ore and coking coal prices in 2016 have certainly cushioned the losses and prevented the bankruptcy of many miners. With the improvement in prices seen in 2016, the direction of iron ore prices is now highly unpredictable as they could move in any direction regardless of fundamentals.

DISCLAIMER: The contents of this report provide only general information on certain investment products. CLTX does not provide, and the provision of such information must not be construed as CLTX providing, financial advice or recommendation for any investment product. The contents should not be taken in any way as an inducement to trade or a solicitation for orders or entry into any legal relations, nor taken as intended in any way to prompt any action or decision on your part whether to undertake or consider undertaking any investment decision or otherwise.