Iron ore price hits 2-year high: Will the bubble burst in 2017?

Fortescue Metals Group Limited (ASX:FMG) has rocketed higher after iron ore hit a two-year high. But will the bubble burst soon?

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Mining giants BHP Billiton Limited (ASX: BHP), Fortescue Metals Group Limited (ASX: FMG), and Rio Tinto Limited (ASX: RIO) look set for another day of gains after the iron ore price rocketed to a two-year high.

According to Metal Bulletin the spot price for benchmark 62% fines closed 3.2% higher on Wednesday at US$82.25 a tonne. This latest jump brings the metal's annual gain now to a staggering 88.8%

Once again it appears that speculative trading from China is largely behind the latest move. Clearly the attempt by Chinese officials to curb speculative trading has been a failure.

This irrational exuberance is eerily similar to the Chinese share market bubble in 2015. During that year the Shanghai Composite index rose a massive 60% on nothing but smoke and mirrors. It wasn't long before the bubble burst and hundreds of thousands of people lost a lot of hard-earned money.

For this reason I would suggest investors keep away from iron ore. With the price being inflated on speculation, there's a fair chance the bubble will burst just like it did with the Shanghai Composite.

Considering the current demand and an expected increase in supply next year, I would place fair value somewhere in the region of US$50 to US$60 a tonne. That's between 27% and 39% lower than the current spot price.

I'm not alone with this view. A report in the Australian Financial Review reveals that global investment bank UBS has warned of a pullback in iron ore prices in 2017.

UBS has forecast for iron ore prices to fall to US$60 a tonne in the next six months, believing that a surplus will develop next year and inventories will pile up.

Fellow investment banks Barclays and Citigroup are also of the opinion that prices will fall. These two brokers are even more bearish than I am, and have forecast a drop to US$53 and US$48 a tonne respectively next year.

Whist speculative trading may take iron ore even higher over the coming weeks, eventually that bubble will burst. I wouldn't want to be holding iron ore shares when it happens.

Motley Fool contributor James Mickleboro has no position in any stocks mentioned. 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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