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Why the Iron Ore Port Inventory Points to an Unsustainable Rally

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China’s iron ore port inventory

China’s (MCHI) iron ore port inventory is a key indicator that reflects the supply and demand balance as well as the safety net and imbalance between the iron ore supply and the steel mill demand.

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Is the rally supported by fundamentals?

While the iron ore prices have rallied recently on restocking by the steel mills in China, the inventory at ports doesn’t suggest that the current rally is supported by underlying demand uptick. The inventory remains elevated at 94.5 million tons as of March 11, 2016, according to the data collected from 44 ports in China by SteelHome. This is an increase of 19% from the October levels. An uptick in demand would have entailed destocking of inventory at ports before fresh orders were placed.

Inventory remains elevated

This inventory translates into an inventory-to-steel production ratio of 1.5x. Often preferred by analysts over raw inventory figures for tracking progress in the sector, this ratio measures how much inventory is available to keep actual steel production activity going. To put things into perspective, the five-year average ratio is 1.46x the amount of steel production.

The slowly increasing inventory at ports amid weak steel demand is hurting iron ore prices, which is negative for the iron ore players involved in the seaborne iron ore trade including BHP Billiton (BHP) (BBL), Rio Tinto (RIO), Vale (VALE), and Cliffs Natural Resources (CLF). The SPDR S&P Global Natural Resources ETF (GNR) tracks the natural resources index. BHP forms 5.0% of its holdings.

In the next part of this series, we’ll look at the steel production and demand outlook for China, which is vital in determining the outlook for seaborne iron ore prices.

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