[ferro-alloys.com] Iron ore markets can be a bewildering beast at times. One minute prices are plunging, the next they’re flying higher.

Like a cat on a hot tin roof, they’re all over the place, testing the resolve of even the most seasoned investor.

Just look at the price action over the past year. From despair to jubilation to despair once again, all in the space of just 12 months.

One of the more bewildering factors investors have had to do with recently was why iron ore spot prices, after moving in lockstep with steel prices until earlier this year, suddenly disconnected in late February, plunging over 40% before bouncing strongly in mid-June.
 One factor that many pointed to was a build in Chinese port inventories in the first half of the year, leaving them sitting at the highest level on record, according to data from Shanghai Steelhome.

However, while that may have contributed to some of the weakness in iron ore recently, Matthew Hope, equity research analyst at Credit Suisse, says that ballooning inventory levels were merely an excuse used by some to help explain the sudden price drop, rather than the actual factors behind the move.

“The street is obsessed with ever-rising port stocks,” he wrote in a note released earlier this week.

“These stocks seem a clear indication that iron ore is over-supplied so for commodity analysts, that means the price should fall until some supply is destroyed to restore balance.

“Therefore, when the iron ore price is rising, analysts publish grim warnings that this can’t last due to too much supply. When the price falls again, the analysts feel validated that they were right, and promptly downgrade price forecasts because it’s ‘the end.”

Rather than inventory levels, Hope says the recent drop was caused by destocking from Chinese steel as they sold down cargoes to meet loan repayments at the end of June.

“Through June, mills were dumping contractual iron ore cargoes into the seaborne market to raise cash for loan repayments,”says Hope.

“Additional cargoes for sale put pressure on the seaborne price, but once the loans were sorted those cargoes needed to be replaced so the restock started.”

So mills were selling ore to raise cash so that they could meet their loan repayments. Once those obligations were paid, mills went from being sellers to buyers, helping to explain the 20% plus rally seen in the second half of June.

According to market provider Platts, the market was “swarmed by buyers” in the last few days of June.

While that goes someway to explaining the recent price recovery even with port inventories continuing to swell, what investors are really interested in is where prices will head next?

In Hope’s opinion, there’s likely to be more upside to come over the September quarter.

“Despite the run-up in the iron ore price it remains below our Q3 price forecast of $70 a tonne,” he says, noting that prices should be supported over the coming months given it is a seasonally a strong period for steel production and consumption.

And, in his opinion, there are additional factors to consider this year that could underpin iron ore demand, and as a result prices, even further.

Temporary limits on steel production in China between November to February due to environmental concerns.

“The steel industry in Hebei, Henan, Shanxi and Shandong is expected to cut output by 50%,” says Hope.

“If this policy is enforced — and smog is a high priority issue — then steel output may fall by 35-45 million tonnes over the three months.”

Hope says that if steel prices remain high it could lead to overproduction as mills attempt to build inventory levels in the second half of the years.

“If this is so, Q3 iron ore buying could be extra strong.”

According to Metal Bulletin, the spot price for benchmark 62% fines stood at $63.23 a tonne on Tuesday.

• [Editor:Wang Linyan]