Chinese steel prices are enjoying a powerful rally, but the gains may just be a false dawn as the issue of excess capacity remains unresolved.
Rebar futures in Shanghai soared 6 percent on Wednesday, extending a three-day winning streak to close at a 14-month high.
Prices are more than 40 percent higher year-to-date thanks to a period of tightened supply and healthy demand from the real-estate market, which accounts for 50 percent of Chinese steel consumption. The rally represents a turnaround from a more somber mood last year as concerns over China's economic health caused prices to tank.
Mainland steel companies were making huge losses last year so they cut back production quite sharply, resulting in mills, traders and end users in the manufacturing sector rapidly using up existing stocks towards the end of 2015 and early this year, explained Paul Bartholomew, senior managing editor at Platts.
That led to stronger-than-usual seasonal restocking typically seen over the Lunar New Year period, reflected in March data showing the world's biggest steel producer churning out a record 70.65 million tonnes of output.
Iron ore, a key ingredient in steel-making, has latched onto the momentum. On Wednesday, ore delivered to Qingdao rose to a 10-month high of $64.77 a tonne, according to the Metal Bulletin benchmark.
Bartholomew questioned the extent to which the rally was being driven by demand as opposed to sentiment.
Speculation has always been a key feature of the steel market, with retail investors often responding to government policy announcements related to fiscal stimulus or structural reforms, he said.
The fact that manufacturing Purchasing Managers' index (PMI) improved in March indicates steel's gains aren't entirely sentiment driven, but a look at the metal's fundamentals still suggests downside ahead, he added.
The property market is still plagued by a massive overhang from all the stimulus brought on by the global financial crisis, he noted. In the first quarter, land leased for building new apartments fell 11 percent, indicating a lack of land for new construction, he continued.
Global credit insurer Coface shared the same dim outlook.
"The market is not expected to regain equilibrium before 2018," analysts said in a Wednesday report.
"While global production is weakening (down 3.1 percent at end-February) and one-third of steel production lines are at a standstill, supply is still abundant," they continued, citing China's growing production capacity.
Only in 2018 will the market witness re-balancing of supply and demand as China's first capacity reductions begin to materialize, the report said, with the automotive, machinery and construction industries leading overall demand.