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Iron Ore's Price Spike Is 'Unsustainable'

Iron Ore's Price Spike Is 'Unsustainable'

Analysts have a bearish outlook on iron ore prices, saying that the recent surge in the prices of iron ore is "unsustainable." Citi remains bearish short-to-medium term on iron ore prices, while Axiom Capital expects the prices to come down in the second quarter.

Iron ore prices rallied by over 60 percent from 2015 lows and a gravity defying 20 percent rise in a single trading session on Monday. The recent iron ore price rally has primarily followed the Chinese steel price rebound led by sentiment around real estate market recovery, sharp credit growth in January, and policy signals released during the National People's Congress.

"We believe this price rally was largely driven by positive sentiment on China, while supply and demand fundamentals remain weak," Citi analyst Heath Jansen wrote in a note.

Supply May Be Backloaded

The first quarter typically sees weaker seasonal supply out of China and in seaborne markets due to winter weather. But the analyst's expectation for supply growth in 2016 remains back-loaded, with greater availabilities in the second half.

Recent headlines about a memorandum of understanding between Vale SA (ADR) (NYSE: VALE) and Fortescue Metals (OTC: FSUMF) might have implications for iron ore price support in the longer term.

However, for the near term, Jansen continues to expect an oversupplied market as supply and demand fundamentals remain weak in the short term, with Chinese steel mills restarting idled furnaces under current prices.

"In the medium term, while Chinese demand may face downside risks of underinvestment in real estate and infrastructure projects, supply from the Big 4, Minas Rio and Roy Hill should remain strong, and junior miners may consider restarting," Hansen said.

Citi is forecasting an annual average iron ore price of $38/t for 2016, $35/t for 2017 and 2018.

China Limits Steel Production

Separately, Axiom Capital Markets analyst Gordon Johnson II said iron ore prices rallying on upcoming Tangshan horticulture exposition. Tangshan city is located in China's Northeastern Hebei Province, which is the country's top steel producing province, pumping out 23.4 percent of total steel output in 2015, and will be hosting an international horticultural exposition between April 29, 2016 and Oct. 16, 2016.

Like many earlier occasions, in an attempt to cut air pollution across the city, the Chinese government is ordering steel mills in the region to lower output – for nearly six months.

"While we do not know any more specifics on how much output the government intends to curtail, we nonetheless believe this is what has driven the magnificent rally seen in iron ore prices," Johnson said in a note to clients.

However, Johnson said the 102.4Mmt of displaced ore demand from the expo is not going to be pulled in all at once (i.e., this shutdown will span six months, giving plenty of time for mills outside Tangshan to make up the difference), implying the recent record one-day move in iron ore prices is largely sentiment-driven.

Thus, beyond the short-term spark that has ignited under iron ore prices, the analyst sees no correction in fundamentals and expects iron ore prices to revert sharply lower in the second quarter of 2016.

"We remind our readers that 33.6Mmt of new supply coming in FY16 from the Big 4 + 200Mmt of China prod. + Roy Hill's 55Mmt (assuming 80% of prod. goes to China) will likely be more than enough to satisfy all of China's '16 iron ore demand – all the while the global cost curve continues to shift lower," Johnson said.

Latest Ratings for VALE

Oct 2020Itau BBADowngradesOutperformMarket Perform
Jul 2020RBC CapitalMaintainsOutperform
Jul 2020BarclaysMaintainsOverweight

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