London, 26 August 2011: Reuters

August has been a cruel month for metals bulls with LME-traded base metals succumbing to the broader macro-economic uncertainty that has roiled markets across the risk-asset spectrum. Some such as aluminium and nickel have fallen back to levels last seen at the end of 2010.

Bellwether copper is putting up a resilient stand just below $9,000 per tonne but the market is collectively uncertain about whether to expect a renewed attack on the earlier price highs above $10,000 or another nerve-rattling leg lower.

No such fears for the iron ore market, where two indexbased spot prices have just hit their highest levels since the middle of May. The Platts index for 62-percent iron ore is currently at $180.25 per tonne, while The Steel Index' assessment of the same grade stands at $178.30.

DEMAND STRENGTH

Nor is there much mystery as to why iron ore prices are still on an upwards arc. The latest figures from the World Steel Association showed global steel production in robust good health in July.

Sure, there was a moderate 3.4-percent dip from June's annualised production rate. That was always to be expected given the "normal" seasonal slowdown over the Northern Hemisphere summer. But the seasonal drag is proving very muted so far this year. July's global output was up by 11.5 percent on the same month last year, while capacity utilisation of 79.7 percent was up a full 4.9 percent points.

China remains the engine of this global steel production strength. National production in July was up by 15.5 percent against year-ago levels. More up-to-date figures from the China Iron and Steel Association showed annualised national production still running at over 700 million tonnes in the first days of August.

The summer is fast drawing to a close and the latest step up in iron ore prices appears to reflect re-stocking by Chinese mills, itself a "normal" seasonal phenomenon. A still-booming construction sector in China is more than compensating for any weakness emanating from the manufacturing sector.

Automotive production growth has slowed to 6 percent this year and broader factory activity is still cooling, judging by the latest flash purchasing managers index.That has dampened demand for flat steel products.

By contrast, fixed asset investment growth in China is still running at over 25 percent and investment growth in real estate was still an eye-watering 33.6 percent in July. The government's social housing programme may have grabbed much of the media attention but that sort of growth rate suggests that the construction boom continues to be much broader based. And that is feeding through into strong demand for long products.

SUPPLY WEAKNESS

Meanwhile, the other component of the iron ore equation, supply, is unchanged. While China's steel production has been running at a 10 percent plus growth rate over the year-to-date, imports of iron ore have been lagging.

Cumulative shipments into China rose by under 8 percent over the same time frame with the growth rate easing further in July itself. A sharp 24.6-percent slide in imports from India, following the ban on exports by the state of Karnataka, has been a key factor.

But so too has been the muted 5.5-percent rise in imports from China's biggest supplier, Australia, thanks to the severe flooding that affected production earlier this year. China has accordingly been diversifying its sourcing of overseas iron ore and maximising internal production.

Domestic production in July was up by almost 22 percent on year-earlier levels. Cumulative production growth was pretty much the same over the January-July period. While the country is forced to rely on high-cost domestic production in the face of constrained overseas availability, the iron ore price looks to have solid underpinning.

MIXED SIGNALS

That combination of super-strong Chinese demand and limited supply is of course the same sort of narrative that defines the likes of copper. Or it did up until a couple of weeks ago. So which market is sending the "right" signal about the state of demand for metals?

Bulls will argue that it is iron ore. Although an iron ore swaps market is steadily taking shape, it is a commodity that is still largely off the radar of investment funds. Prices, therefore, are more beholden to the simple mechanics of supply and demand rather than investment risk-on/risk-off sentiment gyrations. But conversely the lack of exchange-traded contracts means that iron ore and indeed steel are lagging indicators.

Copper's recent price weakness may be due primarily to investor sentiment rather than "fundamentals" but then investment managers are looking beyond the manufacturing strength of the first half of this year and fretting about what lies around the corner. The clash of signals coming from these two key commodity markets cannot persist for long.

Either copper, and to a lesser extent the other base metals, will recover as "fundamentals" reassert themselves, which is what the still numerous bulls hope. Or something fairly nasty is lying ahead for both steel and iron ore markets. If it is, it probably won't materialise first in China. Although the country is the backbone of the current global steel production strength, the old industrialised world has been contributing too.

Core European steel production was up by 6 percent in July and that in North America by 10 percent. These two regions are, of course, the twin sources of the macro-economic fears that have swept across markets in the last couple of weeks. Steel production rates in both will merit close attention over the coming period.

Ends --

By Andy Home, Reuters market analyst – for Commodities Now.

The views expressed here are his own.