Iron ore price jumps, but how much higher can it go?

Source: iStock

The iron ore price continues to defy gravity, rising another 4.1% to US$62.85 a tonne overnight, it’s highest level since March 8, according to Metal Bulletin.

The commodity price lifted 3.6% on Monday too.

And the reason is continuing rises in steel output in China. Steel producers have substantially increased output after China’s government encouraged growth and the property sector staged a revival. But while China has steadily increased output, other steel producing nations like the UK and Australia are being forced to shutter their steel industries, in the face of overwhelming supply – despite recent assurances from China that it would curb production.

Steel oversupply

Source: OECD

30 countries recently attended a crisis meeting in Brussels to discuss the global steel glut. Several countries have also called on China to stop subsidising unprofitable steel producers and are considering measures to protect their steel industries. The European Commission has taken a hard line on its own steelmakers in the past, including ordering the recovery of illegal state aid to countries including Germany, Belgium and Poland.

The European Union is even investigating a €2 billion subsidy from the Italian government to the country’s third-largest steelmaker Ilva, which rivals claim is being used to modernise its plant and increase capacity.

In the UK, Indian steel giant Tata Steel is attempting to sell its unprofitable steelmaking business, but if that is unsuccessful, thousands of workers could lose their jobs. It’s a similar situation in Australia, with the collapse of Arrium Ltd (ASX: ARI) into administration.

At some stage, market forces will begin to gain traction and steel production will have nowhere to go but down. When it does, the iron ore price will follow. The question is when that will happen.

For the moment though, the world’s largest iron ore producers are making hay while the sun shines. Rio Tinto Limited (ASX: RIO), BHP Billiton Limited (ASX: BHP), Brazil’s Vale and Fortescue Metals Group Limited (ASX: FMG) have been expanding their low-cost supply. Rio recently reported a 13% increase in first quarter production, while Fortescue said it may beat its own forecast after quarterly production rose 6%. Then you have new supply from the likes of Hancock Prospecting’s Roy Hill, which is ramping up to 55 million tonnes of production annually.

Foolish takeaway

We may have been pushing this barrow for some time, but the steel market could remain ‘irrational’ for longer than expected. But when it does eventually obey market forces, iron ore prices could plunge.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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