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Iron Ore Price Rally Defies Coronavirus-Induced Recession

SYDNEY — Iron ore is behaving like a boom-time commodity in an economic recession, confounding many investors who had expected prices to buckle as global steel output drops.

The price of iron ore climbed to $121.40 a metric ton on Thursday, achieving its highest level in a year despite the coronavirus pandemic, according to data from S&P Global Platts. As steel’s main ingredient, iron ore is one of the world’s most-traded commodities and can influence prices for materials used in everything from cars to apartment towers.

Driving prices higher is China’s economic recovery after Beijing countered the effect of the pandemic with stimulus measures targeted at infrastructure and construction projects, which require a lot of steel. Recent data suggest Chinese manufacturing activity is also accelerating. Steel is widely considered to be a proxy for Chinese economic activity because roughly 90% of production is used locally.

Still, iron-ore prices were on a similar trajectory in 2019 only to crash by around one-third from a five-year high of $126.35 a metric ton set in early July of last year. Many forecasters have been expecting similar declines through the remainder of this year, especially as steel demand outside China remains weak.

“The iron-ore price started rolling a lot earlier in 2019, and that’s telling us that the market is tighter than a lot of us are giving it credit for,” said Sam Webb, an equity research analyst at Credit Suisse in Australia.

Mr. Webb expects iron ore will average $85 a ton between October and December, but says the case for prices staying stronger for longer is building as China’s economic recovery gathers speed.

China produced 91.6 million tons of crude steel in June, up 4.5% from a year earlier, the World Steel Association said. In contrast, global steel production fell by 7% over the same month led by steep declines in the U.S., Europe and India.

“Our channel checks suggest that both infrastructure and housing are driving demand and the speed at which finished steel inventories have fallen further confirms the consumption strength,” Mr. Webb said of China. In June, spending on infrastructure in the country rose by 6.8% and new housing starts increased by 8.9%, he said.

Mining companies are also upbeat as China keeps the credit taps open. Steel capacity utilization rates in China rebounded above 90% in June, from close to 70% when the virus peaked locally. Iron-ore stocks at Chinese ports are below year-ago levels.

BHP Group Ltd. BHP +2.67% said last month that it thinks Chinese steel production could rise this year if the country avoids a second-wave virus outbreak.

“A year ago, everyone thought Chinese steel production was going to be lower in 2020,” said Paul McTaggart, a Sydney-based resources analyst at Citi. “China has just got back on the accelerator with steel production in a way that wouldn’t have happened without the Covid-19 outbreak.”

A sharp fall in prices of another key ingredient in steelmaking, metallurgical coal, is supporting profit margins at Chinese mills and encouraging high production rates, he said.

Still, many doubt the durability of the rally in iron-ore prices as steel output is weak in almost every market other than China, including in the U.S. where production fell 35% in June. China is entering a seasonally weak period of construction, which may restrain demand for iron ore.

The commodity’s recent rally also owed much to supply disruptions in Brazil where some mining operations had to shut down temporarily following virus outbreaks. However, Vale SA VALE +2.02% said output in June rose by 23% compared with the average for the previous five months, and it stuck with annual guidance for production of as much as 330 million tons.

When the iron-ore price rose above $110 a ton last month, Morgan Stanley wrote that the commodity was “becoming more detached from its fundamentals” and that speculators were setting the market up for a painful reversal.

“The current disconnect could set iron ore up for a significant price decline, bringing to mind the $40/ton correction in August 2019, when Vale’s shipments improved over the summer,” Morgan Stanley said. The bank expects the iron-ore price to decline to $80 a ton by the end of December.

Citi’s Mr. McTaggart also expects prices to fall in the fourth quarter of the calendar year, but says the bank’s forecast for iron ore to fetch an average $65 a ton in 2021 increasingly looks too low.

“With all the stimulus in place I think that will underpin Chinese steel production over the next 12 months at around one billion tons or so,” he said, which is roughly what the country produced in 2019.

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