Key Points:

• After trending lower across 2015, iron ore prices staged a short-term volatile rally in early 2016 – returning close to US$70 a tonne in late April. This coincided with a rapid increase in Chinese futures market trading volumes on the Dalian Commodity Exchange – which may indicate a temporary speculative bull market. Subsequent tighter regulation on the DCE brought prices back nearer to US$50 a tonne.

• This rally occurred against a backdrop of stronger Chinese steel market conditions – with demand recovering thanks to a rebound in construction activity (the sector that accounts for over half of China’s steel demand). Steel prices rose faster than input costs between February and April, driving steel maker profitability to its highest level in almost seven years.

• We argue that the rebound in construction is not sustainable, with policy changes that have relaxed purchase requirements, looser credit and the poor performance of alternative investment options re-inflating the property bubble that had somewhat deflated across 2014 and 2015.

• The short-term boost to profitability should not be allowed to overshadow the significant long-term challenges that China’s steel industry needs to address. Excess capacity in China’s steel sector exceeds 300 million tonnes (around three times the 2015 output of Japan, the world’s second largest steel producer).

• Medium term trends for steel – both in China and globally – appear subdued. Expectations that China’s steel consumption will continue to decline in coming years will be a major constraint on iron ore demand, while sub-trend economic growth elsewhere provides little opportunity for China’s declines to be offset. Over the medium term, we expect prices to settle at around US$40 a tonne.

For further analysis download the full report.

• Iron ore riding an unsustainable wave (PDF, 303kb)

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