Why tapering could take iron ore to record highs

Ian Waldie | Bloomberg | Getty Images

Iron ore prices hit their highest levels in nearly five months, leading one analyst to forecast a further rally of up to 30 percent this year.

Prices of the industrial metal climbed to $141.80 per metric ton on Tuesday, a more than 60 percent increase from lows of around $86.70 per ton in September last year amid heightened fears over a Chinese economic slowdown.

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Sentiment was buoyed heavy steel restocking in top consumer China on news the government will take softer approach on price control.

Recent better-than-expected import data from China also boosted sentiment. July imports jumped 17 percent on June's levels to a record 73.14 million metric tons, data showed on Thursday.

"I believe we can approach record highs this year [in the iron ore market]. You are looking at a 20-30 percent increase," Jonathan Barratt, founder of Barratt's Bulletin, told CNBC.

Iron ore, a key component of steel, hit a record high of $191 per metric ton in 2011 on back of huge demand from China.

Barratt said the iron ore market was set to see substantial gains as the U.S. Federal Reserve's tapering of its bond buying program approaches.

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"In my mind the tapering idea...is highly bullish for iron ore, and a lot of metals including copper, aluminum and nickel," he said.

According to Barratt, U.S. and Japanese corporations are sitting on around $7.7 trillion of cash on their balance sheets. He said Fed tapering will give companies the confidence to start splashing the cash, as they will be reassured that authorities are comfortable with the country's economic strength.

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Most analysts expect tapering to begin in September, if economic data continues to show the recovery is gaining traction. The U.S. central bank has pledged to keep interest rates low until unemployment falls below 6.5 percent and inflation tops 2.5 percent.

"Tapering will give the green light to corporates to start to spend," he said. "They [corporates] are going to think: 'things are starting to look good,' and rather than spending $1, they will spend $2, and therefore they will need $2 worth of primary imports (like iron ore)."

Iron ore prices will likely see a short term bounce to around $150 per ton between now and September, he said, while further gains should come after tapering starts and corporate spending gets going.

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However, other analysts were less convinced that iron ore prices were set to rise further.

"We are not expecting the price of iron ore to rally over the rest of the year," said David Lennox, resources analyst at equity research firm Fat Prophets.

"We are very comfortable with the current price action as we expect some slowing in demand for iron ore as China moves into winter. The slowing in demand will keep a lid on any rally," said Lennox, adding that he expected iron ore to trade between $130-$140 per ton at the end of the year.

— By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie