Iron ore soars again as steel demand improves

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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 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.

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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

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