×

Goldman sees more pain for iron ore

The iron ore market can't catch a break. The slowdown in China has already hammered prices by close to 50 percent this year and now Goldman Sachs has slashed its price forecast for the raw material used in steel-making.

Seen as a key gauge of the global economy, iron ore prices tanked to $37 a ton last Friday, the lowest since at least 2008 due to a slowdown in construction activity in largest consumer China.

The break below $40 also came a year ahead of Goldman Sachs' schedule, the investment bank said in a report on Wednesday.

There is likely to be more downside, the house added, cutting its price forecast for iron ore to $38 in 2016 – down 13 percent from its previous call of $44.

Goldman tips iron prices to fall to $35 a ton in 2017 and 2018, down 14 percent from its previous prediction of $40.

The downgrade in price forecasts were made to reflect the need to cut 250 million tons, or 18 percent of current supply, of seaborne mining capacity in the next three years.

"The short-term outlook remains exposed to the deteriorating health of the Chinese steel industry. Record export volumes have failed to fully offset a material decline in domestic demand, and operating margins have been under pressure for most of the year," wrote analysts Christian Lelong and Amber Cai.

They estimate the marginal cost of production for a ton of iron ore to be $35.

The bank also expects the pace of mine closures to accelerate in 2016 as producers with negative cash flow struggle to find alternative sources of funding.

Despite closures and planned cuts amounting to 15 million tons a year at producers BC Iron and Kumba Iron Ore, these "were not enough to offset bearish sentiment among steel mills and traders in China, where tight liquidity and depressed profit margins are driving buyers away from the seaborne market," the analysts added.

Iron ore prices may not have bottomed out.

There are still significant downside risks such as a large Chinese steel stock fast approaching those in the OECD.

Even if steel stock per capita were to stabilize at 10 tons by 2040 from the 5.6 tons today, steel consumption would find an equilibrium level at 600 million tons a year—down 17 percent from 2014 with scrap recycling accounting for 47 percent of Chinese steel production by 2040--up from 11 percent today, said Goldman Sachs.

In the same period, iron ore demand will fall by 50 percent on the back of lower steel consumption and higher recycling rates.

"The iron ore sector may have to hibernate for an extended period before alternative steel markets in other regions take over from China and usher in the next bull market," the analysts wrote, pegging long-term forecast at $34 a ton.

Follow CNBC International on Twitter and Facebook.