Iron ore rallied 70% in three months, will it continue?

Global commodity markets were expected to start the week with a bang, though no one expected the kind of rally seen in the iron ore market. But a commitment by the Chinese government to keep growth rates high over the next five years augurs well for the commodities markets that are overly dependent on the Chinese consumption.

On the previous weekend at the annual National People’s Congress in China, the Chinese authorities said they would allow a record high deficit and higher money-supply target to support growth of 6.5% to 7%.

As a result of the announcement, iron ore prices shot up by nearly 19% in a single day, the biggest since 2009 and the highest price jump since June 2015.

The sharp rise in iron ore prices has taken the analysts by surprise. Iron ore is trading at nearly 70% higher ($62 per tonne) from the bottom of $37 per tonne it recorded on December 11, 2015.

But very analysts think this party will last long. According to analysts, the Chinese government may not be able to maintain the stated growth rate of 6.5-7%. In US dollar terms, Chinese exports have fallen by 25.4% year-on-year in February 2016, just shy of the record monthly drop of 26.4% reported at the height of the global financial crisis in 2009. Market expected exports to drop only by 12.5%.

Imports fell by 13.8% in dollar terms, much lower than market expectation. Importantly, iron ore imports fell by 10% in February 2016, defying the rise in iron ore prices.

Naturally, analysts believe that the rise in iron ore prices will not be sustainable since fundamentals do not back it.

Robin Bhar, commodities analyst at Societe Generale, says “We don’t have enough evidence to suggest a turnaround. We’re not seeing a huge upswing in [physical] buying this is a short-covering bounce.”

Statements by Chinese officials also do not give confidence in the rally. Over the weekend, officials vowed to help cut overcapacity in steel, potentially curbing demand for iron ore.

So if the writing is on the wall that demand is not picking up and for either iron ore or steel why are prices rising.

One of the reasons is the fall in the US dollar. A weak dollar, the currency in which iron ore is traded, makes it cheaper for investors to buy and hold. Secondly, some analysts expect stock piling of iron ore given the low prices it was trading at. Sustained low iron ore prices would have resulted in mines closing down and impacting supplies.

But the current rise in iron ore prices is likely to keep the supply tap on. Analysts say that a price of $50 per tonne and above will keep the big iron ore producers profitable.  

In fact analysts fear some more mines to start production on account of the rise, which can cap any further rise in iron ore prices.

But there is one more factor that is likely to keep iron ore prices buoyant. In order to protect their domestic steel producing factories countries are imposing heavy anti-dumping duties. India had done it in February 2016, followed by USA in early March 2016. Chances are that even Europe is looking at imposing some kind of import duties. Given the steep level of protection (upward of 200 per cent), steel producing companies will be willing to pay a higher prices for their ore. Improvement in purchasing power is also a reason that is contributing to higher iron ore prices.

Though there is little fundamental reason for rise in iron ore prices to continue, it is also unlikely that they will fall back to their December 2015 lows unless China resorts to sudden and large scale shutdowns of their plants.