Surprising Surge in Iron Ore Prices Despite Concerns Over China's Economic Prospects

Despite the softening steel demand from the struggling Chinese property sector, the iron ore market has witnessed a remarkable rally. Chinese mills are maintaining their output levels, unfazed by the absence of a definitive government production cap. Additionally, they are working to replenish their dwindling inventories of raw materials.

This surge in iron ore prices brings good news to global mining giants like Vale and BHP. It also reinforces BHP's recent outlook that China, the world's largest consumer and producer of iron ore, will exceed a billion tons of steel production this year.

Remarkably, this price surge contradicts recent lackluster economic data from China. It's happening at a time when companies in the property sector, which are major consumers of steel, are grappling with debt and cash flow challenges.

In the past two weeks leading up to August 25, the most actively traded iron ore futures contract on the Singapore Exchange saw an impressive 13.5% increase. Meanwhile, physical iron ore prices delivered to China have risen by a similar margin.

On August 24, the September SGX future reached a one-month peak at $114.85 per metric ton. Although it slightly eased to $112.27 a ton on Monday, this uptick is significant.

Analysts suggest that most Chinese steel mills are maintaining their production levels in anticipation of a government order to cut output. By doing so, they aim to generate cash flow and secure profits. This strategy is also driving the demand for iron ore.

To maintain their production, steel mills are relying more on hot metal, a precursor to steel production, which requires higher amounts of iron ore. This shift is due to the scarcity of scrap steel amidst the slowdown in the property sector.

"The catalyst for this price surge stems from the growing belief that a nationwide steel production cap might not be imminent. However, the underlying factors are a notably high output of hot metal and reduced inventories during a season of sluggish demand," explained Pei Hao, a senior analyst at FIS based in Shanghai.

Interestingly, Beijing has yet to enforce any limitations on annual steel output, a departure from previous years' efforts to control carbon emissions. While verbal instructions have been given to some mills, no official curbs have been imposed.

Even before this recent rally, iron ore was bolstered by China's unusually high hot metal output—a pivotal factor. As long as this output remains substantial, iron ore consumption will stay steady, providing support to prices, according to Pei from FIS.

The support for prices also comes from the low iron ore inventories at mills and ports, a trend that analysts highlight. Since the latter half of 2022, steel mills have reduced their stocks to conserve cash.

Mysteel's data reveals that imported iron ore inventory among 247 Chinese steel mills declined by 13.5% year-on-year as of August 25. Additionally, Steelhome's consultancy reported that iron ore inventory at major Chinese ports dropped by 15.5% year-on-year to reach 118.6 million tons by August 25.

With these dwindling inventories, steelmakers are compelled to turn to the spot market to meet their requirements. This dynamic is further driving prices through robust near-term demand.

Tomas Gutierrez, head of data at Kallanish Commodities, pointed out that some steel mills have bolstered their inventories through the spot market, contributing to the positive momentum in iron ore prices.

Despite the current momentum, there's a possibility that it might not be sustained. The persistent property slump, coupled with rising iron ore costs, has put pressure on the profit margins of mills.

"The unexpected magnitude of the iron ore price rally has significantly squeezed steel margins," stated a purchasing manager from a major Chinese steel mill. He added that just a month ago, some mills were making gross profits of 400 to 500 yuan per ton. However, the current situation has made it challenging for most mills to maintain profitability. He chose to remain anonymous due to lack of authorization to speak to the media.

Source : Reuters (Reporting by Amy Lv and Dominique Patton)