Iron ore price builds on rally

China is responsible for two-thirds of the 1.2 billion tonne seaborne trade and the decline in the price has been blamed on continued signs of a slowdown in the world’s second largest economy combined with a surge in supply.

The commodity has lost more than 30% of its value year to date and industry-specific factors in China have arguably played a bigger role than fundamentals.

Beijing is clamping down on unofficial financing activities happening outside state-owned banks within the so-called shadow banking system.

The use of commodities – particularly copper and iron – as collateral in trade financing agreements makes up a large portion of the unofficial banking sector.

Inventories of iron ore at Chinese ports declined only slightly from record highs this week falling by 600,000 tonnes to 112.5 million tonnes as of June 13.

More than a third or 38 million tonnes of the stockpiles are held by traders.

Last week’s revelation that authorities are probing whether traders at the port of Qingdao pledged the same copper, iron ore and aluminum inventories as collateral for loans multiple times to different banks has prompted the Chinese regulator to more closely scrutinize these deals and commercial banks making it much more difficult to obtain.

One of the big four banks in the country, China Construction Bank, has stopped issuing commodity-backed letters of credit altogether and are calling in existing loans, meaning traders are forced to dump stocks onto an already well-supplied market reports Reuters:

“Tighter credit will exacerbate the oversupply situation in the market and will send iron ore prices even lower. The next level I’m looking at is $80,” said Helen Lau, senior mining analyst at UOB-Kay Hian Securities in Hong Kong.

Platts News reports that the current uptrend in iron ore and steel may not last due to underlying bad fundamentals, quoting a Zhejiang-based steelmaker as saying:

“Port stock volumes in China have still not been able to go down, and Australian and Brazilian miners have been pumping in so much supply into the seaborne market at the same time. In the later half of the year, this seaborne supply is not expected to ease at all, so supply and demand have not and will not achieve any balance, and this will definitely pressure prices down.”

Imports also point to further weakness ahead.

After a strong first quarter iron ore imports fell back to 77.4 million tonnes in May, down 7.2% from April; a sign that these deals may be unwinding at a more rapid rate than previously thought.

On Monday the iron ore price fell below $90 for the first time since early September 2012.

On a quarterly basis iron ore hasn’t averaged less than $100 since the height of the global financial crisis, but the 2014 second quarter average has now declined to $103.60.