Iron ore prices soared again overnight, rising 4.9% to trade at US$62.27 a tonne, as China’s steel sector recovers.

China’s steel industry purchasing managers’ index (PMI) – came in at 50.2 in July 2016, well above the 45.1 recorded in June. The index measures changes in activity in the steel sector – with reading over 50 indicating expansion.

Growing steel demand

It seems export orders are surging while domestic demand has also increased. Forecasts of a correction in the second half of 2016 have come to nothing, supported by temporary factors such as mining shutdowns and supply disruptions.

Floods in the north of China have reportedly disrupted transport routes, while environmental inspections have also closed some steel mills. Steel prices have soared and China is pushing ahead with major reforms to its industry.

The country’s 4 large steel producers are being merged into two super-giants, one in the north and one in the south, according to EconomicCalendar.com. The largest producer Hebei Iron & Steel Group and Shougang Steel will be combined into Northern China Steel Group, and the second largest Shanghai Baosteel Group will be combined with Wuhan Iron & Steel into Southern China Steel Group. The mergers are expected to help cut some of the inefficiencies in the steel sector.

Slower iron ore supply growth

At the same time, iron ore growth has reportedly slowed. Global production is expected to rise from 3,149 million tonnes in 2016 to 3,275 million tonnes by 2020 – just 0.1% per year, according to BMI Research. That’s down significantly on the 4.8% growth experienced over the four years from 2011 to 2015.

While the larger, low-cost producers Rio Tinto Limited (ASX: RIO), BHP Billiton Limited (ASX: BHP), Vale, Fortescue Metals Group Limited (ASX: FMG) and Hancock Prospecting are expanding their output, higher cost, lower quality ore producers continue to be pushed out of the market.

Foolish takeaway

There are still concerns from some parts of the sector that the steel market remains in backwardation (spot prices higher than forward prices) which could signal that a correction is due, although the situation has existed for some time without a correction.

Macquarie analysts have also questioned whether prices were getting carried away again, and others have flagged concerns over growing port stockpiles.

3 Rotten Shares to Sell, and 1 to Buy Today

After a double-digit rally for the ASX since 2016 lows, investors should be on high alert. You'll find a full rundown below of 3 shares we think you should avoid today plus one top pick worth buying, even if the market turns south and the RBA keeps rates at an "emergency low." Simply click here to uncover these stocks. No credit card required.

HOT OFF THE PRESSES: Motley Fool’s #1 Dividend Pick for 2017!

With its shares up 155% in just the last five years, this ‘under the radar’ consumer favourite is both a hot growth stock AND our expert’s #1 dividend pick for 2017. Now we’re pulling back the curtain for you... And all you have to do to discover the name, code and a full analysis is enter your email below!

Simply enter your email now to receive your copy of our brand-new FREE report, “The Motley Fool’s Top Dividend Stock for 2017.”

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our https://www.fool.com.au/financial-services-guide">Financial Services Guide (FSG) for more information.

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.