China Steelmakers: Iron Ore Rally Is a Fake (BHP, RIO)

Iron ore prices soared by 17% on Monday after China’s policy makers provided a positive outlook for the steel industry with their pro-growth plans to boost the economy. However, the China Iron & Steel Association (CISA), the country’s top steel group, indicated Wednesday that the prices will be reversed in the near future as the global iron ore market is significantly oversupplied, demand is slow in China and the steel industry is witnessing a glut.

CISA’s outlook is consistent with the commodity’s bears such as Goldman Sachs Group Inc. (GS) and Citigroup Inc. (C), who have already indicated that the iron ore rally is unsustainable.

Li Xinchuang, deputy secretary-general of the China Iron & Steel Association, said, “Don’t let wild, short-term price swings distract us from our analysis of the market.” Li added, “How can the rally possibly be sustained?”

China’s steel consumption declined by over 5.4% in 2015 and CISA’s Li expects it to decline by another 3% this year as the country is transitioning from economic growth driven by manufacturing and investment to consumption and services. At the same time, China’s steelmakers continue to increase their production and create an excess supply of steel. (See also: How China Impacts the Global Steel Industry.)

On the other hand, iron ore’s port inventories have already risen by 13% since the beginning of 2016 as per data provided by the Shanghai Steelhome Information Technology Co. This has supported the iron ore prices which have risen by around 60% this year. China purchases about two-third of seaborne iron ore and contributes about 50% global steel production.

Li said, “The iron ore market remains massively oversupplied, and steel consumption in China will extend declines this year.” He added, “Iron ore prices are trading between $40 and $60 a metric ton this year as China’s demand weakens.”

Despite falling by more than 75% in the last five years till 2015, the margins of Iron ore miners such as BHP Billiton (BHP), Rio Tinto (RIO) and Fortescue Metals Group Limited have witnessed high operating margins due to declining delivery costs amid falling oil prices and other cost-cutting strategies. These companies have significantly increased their production in order to protect their market share. (See also: South American Economies Reel from Low Chinese Demand.)

However, CISA’s Li believe that these margins are not sustainable. He said, “How can such margins sustain in the long term? You’ll never find margins like this in any other industry in the world.”

Many market participants believe that the iron ore price rally since the start of 2016 is not sustainable. They believe prices will witness a reverse trend as iron ore supply continues to increase and steel demand continues to decline.