Iron ore traders were the most pessimistic group in a recent survey of commodity practitioners by international commodity and financial services conglomerate Macquarie.

While the downturn in sentiment would point to softness in iron ore prices over coming months, there are signs that any such softness will be relatively well contained.

The Australian financial services giant reports that, “the restocking cycle in iron ore appears to be nearing an end, with iron ore traders the least optimistic group in our survey.”

Since iron ore is the largest export of Australia we are therefore able to read in betwee the lines with regards to the outlook facing the Aussie Dollar which is especially sensitive to the price of commodity.

Any fall in iron ore prices is therefore likely to have a negative knock-on effect on the currency.

The report stands to aggravate concerns raised by the Reserve Bank of Australia (RBA) in recent policy statements; concerns that were reiterated in their March meeting minutes published on Tuesday, March 21.

The central bank highlighted the lop-sidedness of the economy which has seen house prices shoot higher in Sydney and Melbourne but a depression in the resources-rich west coast of the country where iron ore extraction is the primary industry.

This imbalance is one of several factors preventing more aggressive action from the bank to curb mortgage lending by raising interest rates.

And higher interest rates = a stronger Australian Dollar.

The negative outlook for iron ore could therefore be a considerable ball-and-chain for the currency.

What is clear from the above is that sentiment remains bullish by historical standards and well above the longer-term average.

Therefore, the weakness must not be overstated.

Steel Outlook Positive

One silver lining to the iron ore story is that demand for steel remains strong.

Steel mills, the main consumers of iron ore, have just completed a massive restocking push in the face of rising iron ore prices, which have seen huge surge from the mid-40 Dollars per metric tonne in February 2016, to $92 more recently.

The heady days of high iron ore demand are about to fade over the short-to-medium term at least as steel mills are now “well covered” for their forthcoming “ramp-up” according to the Macquarie report.

Given the strong outlook for steel, however, once iron ore inventories are used up a resurgence in demand is expected.

“Steel sentiment softened slightly from five-year highs but remains at historically elevated levels, especially among steel mills. Mill profitability is extremely high, and production is starting to lift, led by medium-sized mills,” say Macquarie.

In China, which is a primary consumer of steel (and Aussie Iron Ore to make the steel), orders for infrastructure and housing remain strong although those for appliances and car manufacturers slowed.

Government attempts to reduce the housing bubble in China have seen tighter borrowing regulations imposed in the 16 largest cities which are the “strictest seen yet.”

Yet house prices as a whole have continued rising due to a spill-over effect into “tier-3 and 4 cities,” said the report.

Demand for steel is still high, therefore, and once current iron ore inventory is used up we will no doubt see a resurgence of demand all things being equal.

Steel production is expected to soar in coming weeks to meet the newfound demand but this may also be sowing the seeds for a supply glut, which could weigh on prices latter on.

Mills generally still have a large capacity pool to use up before operating at 100%, nevertheless Macquarie underscore that draw is very strong at the moment so there is plenty of slack to use up before oversupply becomes a problem.

"Iron ore restocking appears to be easing, as steel mills look well covered for their forthcoming ramp-up in steel output. Steel mills are not yet planning to cut iron ore purchases, however, and iron ore prices should continue to be supported while steel prices remain elevated," say Macquarie.

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