Miners and Australian equities investors may have rejoiced when the iron ore prices rallied in April but their relief will be short-lived as the price will inevitably decline, warns a leading investment bank.
Goldman Sachs commodity analyst Christian Lelong said the recent rally had provided welcome breathing space to smaller producers but was ultimately short-lived and self-defeating with prices due to fall below $US50 a tonne within three years.
"The market outlook remains unchanged. In our view, prices must fall below the cash cost of marginal producers in order to force the mine closures required to balance the market," Mr Lelong wrote in a note to investors.
Iron ore delivered to Qingdao Port in China was trading at $US64.34 per tonne on Tuesday, up from a year-low of $US47 per tonne in early April. But the commodity price has dropped by 47 per cent over the last year.
The price rally came amid briefly tapering supply and low inventory levels in China as well as poor weather that hit deliveries. The low inventories will take some time to replenish so Goldman Sachs is anticipating a short-term continuation of the higher prices before a steady decline.
"In the medium term, we believe inventory levels and export growth normalise and structural drivers will come back to the fore," Mr Lelong said.
The two largest mine closures hit by the April price trough are coming back online and Atlas Iron is due to resume production shortly. But Mr Lelong said it was inevitable more mines would close further down the road once the temporarily high prices abate.
Royal Bank of Canada commodity analyst Chris Drew was also forecasting long-term lower prices for iron ore despite the uptick in May.
"Unfortunately, we do not see this support lasting as supply is set to step up again in H2 2015, pressuring prices," commodity analyst Chris Drew said in a note.
Mr Drew pointed out it was unusual that the same period had seen metallurgical coal prices had dropped almost 20 per cent in the same period, as the two commodities usually trade in tandem.
China's economic ups and downs have a direct impact on iron ore prices and Australia's export activity, of which iron ore makes up about one fifth.
China consumes more than 60 per cent of the world's iron ore production. In 2014, the country purchased 933 million tonnes of iron ore, of which 58 per cent came from Australia.
Despite Chinese monetary stimulus, delayed launches and deliveries by BHP and Vale, and rising Chinese steel prices, Mr Drew said supply would soon outstrip supply in China, driving the iron ore price down again.
"We feel the strength in iron ore is fragile," Mr Drew said. "In quarter three we expect demand to ease as we move past China's summer construction peak; concurrently, supply is set to step up as majors continue expansions. This is likely to see prices testing first half lows."
Goldman Sachs and RBC join a growing chorus of voices warning of long-term lower prices for iron ore as China's economy slows.
In late May, president of China's peak metallurgical industry group Xinchuang Li said local steel production companies compete, driving down their own prices as well as those of suppliers.
"Mining companies are in for a very, very tough time because of our competition," Mr Li said. "Because of it, the price of steel will stay low, which pushes the iron ore price to a low level."
Mr Li said the organisation's understanding of the buyer side of the market meant it was forecasting iron ore prices to remain within $US55 to $US65 per tonne for at least two years.
Source:The Sydney Morning Herald
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