Iron ore could be about to crash

The spot iron ore price fell for the second time overnight, losing 0.8% to US$57.87 a tonne, and follows a similar fall for the day before.

But iron ore futures on the Dalian Commodities Exchange fell by 4.8%, down 8.6% from the highs hit earlier this week, and steel (rebar futures) prices have also slumped on the Shanghai Commodities Exchange.

The decline of both futures contracts suggests the brief iron ore rally could be coming to a dramatic end.

We’ve mentioned this a few times – that the iron ore rally was most likely a result of temporary factors rather than a structural change in the market.

Those factors include:

  • A temporary surge in steel production (and iron ore stocking) before a series of rolling shut downs of steel mills in a major steel producing city, Tangshan, over the next six months. Those shut downs are to reduce levels of pollution during a Horticultural Expo
  • Brazilian iron ore giant Vale warning that up to 100 million tonnes of production was at risk due to outstanding environmental licences
  • Steel mills stocking up after the Chinese New Year in February
  • Steel prices rising on the hopes of renewed domestic demand in China

Taking those factors out, and both the supply and demand sides of the iron ore equation look weak. Steel demand and production is forecast to fall for a number of reasons, while production continues to ramp up globally, adding to the already oversupplied situation.

For higher cost producers, particularly smaller miners like BC Iron Limited (ASX: BCI), Arrium Ltd (ASX: ARI), Atlas Iron Limited (ASX: AGO), Gindalbie Metals Ltd (ASX: GBG)Mineral Resources Limited (ASX: MIN) and Mount Gibson Iron Limited (ASX: MGX), that’s not good news.

A number of them have seen their share prices soar in the past month, but the upward trend could be about to reverse course.

Foolish takeaway

Investors gambling on higher iron ore prices are taking a big risk – with many analysts pointing to lower prices in the second half of this year, and there’s no real reason to expect a major price recovery anytime soon.

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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

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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