Fall in iron ore prices is a pointer to commodities market fragility

What goes up on unrestrained speculation will inevitably be back on earth at some stage. We saw it when iron ore speculation defying fundamentals took the mineral's price to a peak of $70.46 a tonne in the third week of April this year - a rise of 80 per cent since December 2015.

Buoyed by weather-related iron ore supply disruptions in Australia, fresh stimulus measures by Beijing and routine moves by China to start rebuilding inventories in the year's beginning, speculators went on marking up prices. Ore stocks at Chinese ports at close to 100 million tonnes (mt), the highest since March 2015, signals the end of inventory build up linked imports for some time.
 
No doubt, demand has rebounded in the world's largest market for steel as Chinese production surge in March and April will bear out. Steel prices in China are up 70 per cent from their November low, leading to significant improvement in the working of the country's major steel mills. But, benchmark ore with iron content of 62 per cent for delivery at China's Qingdao port has slipped below $55 a tonne as operators have started contending with what might be in store for the mineral in the coming days. Many experts, including Lakshmi Mittal, stay worried about the fragility of the steel market. Mittal is happy about the recent improvement in spreads, constituting the difference between raw materials costs and steel products prices in the core markets of his group. Nevertheless, he says: "Given the levels of excess capacity in China, the steel market remains fragile. We must, therefore, continue to be vigilant and active against the threat of unfair trade."

Mittal's concern found resonance in the proceedings of the recent Brussels meeting of associations of eight major steel-making countries. What proved to be a disappointment, though, was the reluctance of China, which hosts a major portion of global steel overcapacity of around 700 mt to partner other governments in a 'programme of actions' to set the industry in order.

No doubt 'structural and cyclical economic developments' in the past couple of years have painted the industry into a corner. But, it would have been better placed to negotiate the difficulties had it not been for government supportive measures, seen particularly in China, contributing to significant excess capacity and distortions in global steel trade flows.

The principal recommendation of the Brussels meeting is that no government or government-backed institutions should be found supporting 'consistently' loss making steel plants, encouraging investment in new capacity which, in normal course, would not be there and doing things that lead to trade distortions.

Around the time pitfalls of overcapacity were discussed, the rise in Chinese domestic steel prices to 19-month highs led some mills firing up of furnaces lying idle. What is feared is that price improvement is the reason for high production in China, which all will not be consumed in the domestic market. Pressure will, then, automatically build up on the industry to seek markets abroad for surplus steel. Many steel-producing countries, including India, cried foul last year when China's exports rose 20 per cent to 112.4 mt. Such high levels of exports were the reason for the Chinese industry getting embroiled in trade frictions with the US, European Union and India.

While India's trade action was by way of introducing minimum import price (MIP) on 173 steel products ranging from $341 a tonne to $752 a tonne earlier this year, some other imports injured nations took even harsher steps. Thankfully, world steel prices are still either at MIP level or slightly higher than that. But, mark ArcelorMittal chief financial officer Aditya Mittal saying it is possible "Chinese steel prices have overshot leaving room for correction". It will be instructive to recall what Goldman Sachs said in a report when prices of both ore and steel were in ascendance that the rally looked unsustainable as the tight Chinese steel market could turn out to be a temporary distraction.

Hasn't the World Steel Association (WSA) in its demand assessment for the year said Chinese steel use would contract by four per cent to 645.4 mt and then again by three per cent in 2017 to 626.1 mt? Why China alone, the global steel demand will shrink by 0.8 per cent to 1.488 billion tonnes (bt) this year, according to WSA. This follows a three per cent demand fall in 2015. India, however, should be an exception where a 5.4 per cent demand improvement both in the current year and 2017 is forecast by WSA.