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Are 12-Year Highs in Iron Ore Inventories an ‘Ominous Sign’?

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China’s iron ore port inventory

China’s iron ore port inventory reflects the commodity’s supply and demand balance. It also indicates the safety net and imbalance between iron ore supply and steel mill demand. A high inventory is a sign of weak demand for raw materials, and vice versa.

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Inventories at a 12-year high

Iron ore inventories at Chinese ports rose 22.4% in 2016, the largest annual rise since 2011. Port inventories stood at 118.2 million tons on January 13, 2017, the highest level since 2004.

Iron ore inventories at Chinese ports have reached a 12-year high. This inventory level translates to an inventory-to-steel production ratio of 1.78x.

An inventory-to-steel production ratio is often preferred by analysts over raw inventory figures for tracking progress in the sector. The production ratio measures how much inventory is available to keep steel production activity going. The average for this ratio over the last five years is near 1.5x.

As cited by Bloomberg, Axiom Capital Management said, “If history is any precedent, record stocks at Chinese ports carry an ominous sign.”

Negative fallout expected

Increasing inventories at ports amid steel demand that doesn’t seem sustainable could hurt iron ore prices. This trend is negative for 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 makes up 5.0% of GNR’s portfolio holdings.

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

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