Chinese rate cut stokes iron ore rally

Iron ore, the key ingredient in steelmaking, has extended its recent breathtaking rally after China cut interest rates for a third time in six months in a further attempt to shore up its slowing economy.

Benchmark Australian ore for immediate delivery into China rose $2, or 3 per cent, to $62.50 a tonne on Monday, according to a price assessment from The Steel Index. Iron ore has now surged almost 35 per cent since sinking to a six and a half year low of $46.70 in early April.

China is the biggest consumer of seaborne iron ore, purchasing around two-thirds of the world's supplies. The latest rate cut should lower borrowing costs and ease the pressure on the country's heavily indebted steelmakers.

A decline in Chinese ports stocks and a late buying spree by steel mills restocking ahead of the peak summer demand period have been the key drivers of the recent recovery in iron ore prices.

In addition, three of the four largest seaborne producers - BHP Billiton, Fortescue Metals Group and Vale - have all suggested they might be willing to adjust production volumes, which have surged in recent years and overwhelmed weaker demand.

However, many analysts do not expect the recovery to last and believe prices will fall unless Chinese demand picks up or there is a real commitment to cut supply on the part of major producers.

"We believe the current price rally does not signal an inflection point, and market fundamentals will reassert themselves sooner rather than later," said Goldman Sachs analyst Christian Lelong in a report.

"Investors may consider this as a window to take short positions in the sector, while iron ore miners could use this opportunity to hedge future production before the downward pressure on prices returns."

Mr Lelong said iron ore exports from Australia and Brazil had "misfired" in April, forcing Chinese steel mills to draw from inventory while port stocks fell by 10m tonnes to 86m tonnes.

"However, a return to normalised export growth in Australia and Brazil is likely to result in a gradual increase in inventory levels and allow prices to resume their downward trend," he said.

After the recent supply hiccup, Melinda Moore, analyst at ICBC Standard Bank, said she expected shipments to pick up this week, by around 2m tonnes from the majors. "As well, local surveys suggest domestic ore miners have lifted output by 3-5 per cent since the mid-April price recovery," she said.

However, Ms Moore said the iron ore price would not suffer a large sell-off until Rio Tinto - the world's second biggest supplier - completed the next phase of expansion at its mines in Western Australia.

Rio's plans and those of rival BHP have drawn sharp criticism in Australia. On Monday, Andrew Forrest, the chairman and biggest shareholder in Fortescue Metals Group - the world's fourth biggest producer - called on the Australian government to stop the expansion plans, saying they were jeopardising the economy.

"Write, email or ring your local Parliamentary Member. Be clear in your views," Mr Forrest said in an editorial in Sydney's Daily Telegraph newspaper. "Ask government to consider multinationals' licence to operate in Australia if they don't market Australian iron ore responsibly for all Australians, not just their global market share."

Rio and BHP did not respond to the comments by Mr Forrest but they were slammed by the Minerals Council of Australia for threatening to set the country on an "interventionist" path.

"A government direction to reduce Australian output would have a damaging impact on the iron ore sector and on Australia's reputation as a reliable supplier and as a secure investment destination," said Brendan Pearson, the Mineral Council's chief executive. "It would represent a giant free kick to Australia's competitors."

Analysts said the rally in the iron ore price has been mirrored, albeit to a lesser extent, by base metals and oil in recent weeks. Some believe this reflects an increasing influence from financial speculators.

Volumes of iron ore futures contracts on SGX, the Singapore stock exchange, and the Dalian Commodity Exchange in China have been growing quickly, helping to drive a transition to a financial-led market, they said.

"One of the more noticeable trends in the past month has been the rapid divergence of iron ore and other steelmaking raw materials, such as metallurgical coal or manganese ore", analysts at Macquarie noted.

"Without any financial market distortion, the lesser steelmaking raw materials perhaps better reflect the subdued feeling of the global steel industry, given low (if potentially bottoming) prices and relatively weak demand growth."

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