Futures & Commodities

Here’s why iron ore prices aren’t rising anytime soon

Iron ore prices are unlikely to stage a decisive recovery anytime soon as a supply glut continues to flood a market hit by slowing demand, sending prices to four-month lows this week, analysts say.

Seen as a key gauge of the global economy, the raw material used in steel production is under heavy pressure as construction activity slows in largest consumer China. Normally, that would spur companies to curtail production.

Except, companies are increasing output as prices remain above their production costs.

"Prices will continue to fall because of economies of scale enjoyed by miners due to the large production volumes," said Mohd Taufik, who manages the over-the-counter trading desk at the Singapore-based brokerage Phillip Futures as a business development manager.

"Due to economies of scale, with lower cost, they can lower prices as well."

According to The Steel Index, iron ore for immediate delivery to China's Tianjin port hit the four-month low $48.70 a metric on Tuesday—about a third lower since the beginning of year. The most active January iron ore futures contract on the Dalian Commodity Exchange was at CNY348.50 ($76.78) a tonne at midday on Wednesday after hitting a 16-week low of CNY345 on Tuesday.

The price declines come on the back of recent statements from industry executives who are still seeing dark clouds on the horizon.

Read More BHP maintains FY guidance as Q1 iron ore production jumps 7%

A senior BHP Billiton executive said he is bracing for an extended period of depressed iron ore prices as he expects prices extend declines in the next few years before finding a new normal below $US50 a tonne, reported the Australian Financial Review on Tuesday.

"In medium term, the next few years, it's going to be much of same, we will continue to see very modest demand growth, and strong supply growth outpacing demand. That pressure will continue to gradually push it (the price) down – because the rate of displacement will get slower," said BHP's vice president of marketing for iron ore, Alan Chirgwin.

Last week, the chairman of China's second largest producer Shanghai Baosteel Group, Xu Lejiang, told Bloomberg that the country's steel output may slump as much as 20% amid an industry gloom that is hurting production of the industrial commodity.

Despite slowing demand in China, the world's top three iron-ore producers—Brazil's Vale SA as well as Australia's BHP and Rio Tinto—continue to churn out record volumes of the product as the companies rely on low cost of production to bolster their earnings.

The increased production is a theme that will continue to drag on iron ore prices.

According to data compiled by Westpac, Australia's big three iron ore producers— BHP Billiton, Rio Tinto and Fortescue Metals Group—have produced a fresh record high of 193 million tons of iron ore in the third quarter of 2015—a 8.5 percent rise from a year ago. Guidance from all three companies recently also confirms strong production in the coming quarters.

World largest iron ore production Vale's output also hit a record high in the quarter and is expected to continue increasing as output from a major project comes on stream next year.

Westpac's head of financial markets strategy, Robert Rennie said in Singapore on Tuesday that the house is forecasting weak iron ore prices to stay in the $45-55/ton range until 2017.

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