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Why Citigroup Doesn’t Think the Iron Ore Price Rally Will Last

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Rally not meant to last

Like the majority of other analysts, Citigroup (C) believes that the current iron ore price rally is not meant to last for long. Iron ore prices rose ~23% in 1Q16 despite analysts’ warnings of a pullback around the corner.

Citigroup contends that short-term factors such as supply disruptions and a rebound in steel prices helped iron ore prices year-to-date (or YTD). However, Citigroup maintains that these gains should be reversed in the second half of the year on the back of “severe oversupply.”

Citi has raised its average iron ore price forecasts from 2016 through 2018. Citi expects iron ore prices to average $45 per ton in 2016, $39 per ton in 2017, and $38 per ton in 2018. It maintains that while price falls have been delayed, they are still coming.

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Basis for bearish view well founded

Citi’s fears are well-founded. There’s still a supply behemoth expected to hit the markets in the second half of the year. Vale’s (VALE) 90-million-ton-per-year iron ore project S11D will likely start supplying in the second half of 2016. Vale’s S11D project is located in the Carajás mining district in the Pará region of Brazil.

The S11D project should increase the mining and processing capacity at Vale’s Carajás mining complex by 90 million tons per year to 450 million tons. This area is very rich in iron ore content and produces ~67% iron ore.

Supply behemoth

When Vale’s S11D project comes online, it could be a further game changer in the iron ore market. Its cash costs per ton would be less than $10 per ton. The addition of 90 million tons in the lowest quartile of the iron ore cost curve could be disruptive for high-cost producers, especially given the fact that Chinese consumption is not expected to pick up at the same pace in order to absorb excess supply.

This could put downward pressure on prices. While mining giants such as BHP Billiton (BHP) and Rio Tinto (RIO) can weather this downturn, smaller and more marginal players will likely be crushed. US-based pellet producer Cliffs Natural Resources (CLF) will be impacted indirectly through the iron ore glut in the seaborne market.

Vale SA forms 1.8% of the iShares MSCI Brazil Capped ETF (EWZ). Now, let’s have a look at what other analysts on the Street have to say about iron ore prices.

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