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The swift and unexpected rally in iron ore prices could be approaching its peak, strategists warn, as seasonal supply concerns caused by La Niña unwind and markets determine how China will balance its desire to stimulate growth with plans to reduce emissions.

The price of Australia’s number one export reached $US131.60 a tonne in the spot market this week, according to S&P Global Platts, signifying a 50 per cent jump from the lows reached in November and the highest level since October. Prices eased on Thursday to $US127.95 a tonne.

The price of the bulk commodity has been boosted over the past two months by signs of improving steel output in China and the expectation of more stimulus to fuel growth in the world’s second largest economy.

But the rally intensified this week as heavy rain in south-east Brazil, which has been linked to the La Niña climate event, forced the world’s second largest producer, Vale, and other local producers to halt operations. The overnight fall in prices reflected reports of easing weather conditions in the major ore-producing regions, according to NAB.

While markets have moved to factor in the seasonal disruption to supply and a move to more aggressive stimulus in China following the Beijing Winter Olympics, some strategists are convinced prices are unsustainable hereafter.

“You can see why the market is moving near-term spot prices higher because there are a lot of risks, but as we move through the first quarter and get a better understanding of stimulus in China post-Olympics, that’s when we see prices easing,” Westpac senior economist Robert Rennie said.

“I expect to see prices peak in the coming weeks and begin to soften, assuming no other major weather events.”

Spike in Chinese demand

The rainy season, which occurs in the opening months of the year in Brazil, comes with the potential for wet weather and cyclones in Australia, and colder weather in Canada and Russia. This usually leads to lower shipment rates and iron ore availability.

The deluge in Brazil, China’s second-largest source of iron ore, has not forced an adjustment to Vale’s 2022 guidance, despite the restricted southern and south-eastern operations accounting for about 40 per cent of its iron ore production in the first three quarters of last year.

Supply constraints have coincided with a spike in demand as steel mills restock ahead of China’s Lunar New Year holiday, which starts next month, but even so, a rapid bounce in China’s steel production appears unlikely, according to Mr Rennie.

“Steel prices haven’t really moved over the last few weeks, and I expect shutdowns to remain in place to improve air quality leading into the Olympics,” he said.

“I’m also not as optimistic as the market that we will see a sudden recovery in Chinese construction and steel demand. I think the low levels are a story in place for this year and beyond.”

Westpac forecasts iron ore to drop to $US88 a tonne by the middle of 2022, falling to $US75 a tonne by the end of the year.

Bullish argument

The bank’s outlook stands in contrast to that of Morgan Stanley, which has labelled iron ore as its top commodity pick on a six-month time horizon.

The broker sees further upside from current prices, especially as China’s steel mills start ramping up production from March onwards, it said in research this week.

“We are not convinced a tighter market ahead is fully priced in by now,” Marius van Straaten, a commodity strategist at Morgan Stanley, said. “When improving steel production and falling port inventories become reality, we expect modest further price upside.”

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While conceding it is unlikely that the Chinese government will allow for full-year steel output to expand this year given its commitment to lowering carbon emissions, the broker said its short-term bullish view was based on a “sequential steel production recovery”.

“Even under such a no-growth constraint, we can see a potential 25 per cent increase in steel run-rates by the second quarter of 2022 versus October-November levels,” Mr van Straaten said.

Acknowledging the bear case that China’s property slowdown will continue to drag on steel demand this year, the broker argued that China’s property industry “will face a managed slowdown” rather than a hard landing.

Morgan Stanley’s forecasts issued last month predicted iron ore to sit at $US115 a tonne in the second quarter, before dropping to $US85 a tonne in the fourth quarter.