--Clyde Russell is a Reuters market analyst. The views expressed are his own.--
By Clyde Russell
LAUNCESTON, Australia, June 5 - It's probably too early for iron ore producers to get excited about the rebound in prices this week, but there are signs that the current three-month slump may be easing.
Spot iron ore .IO62-CNI=SI jumped 4.2 percent on Tuesday to $116.60 a tonne, recovering some of last week's more than 10 percent plunge.
However, the shape of the futures curve of iron ore swaps traded in Singapore <0#SGXIOS:> doesn't suggest a rally is imminent, rather it's pointing to less downward pressure.
The curve was in mild backwardation in early trade on Wednesday, with the six-month contract trading at $114.87 a tonne, 97 percent of the value of the front-month contract.
This stands in sharp contrast to the strong backwardation that prevailed on Feb. 20, when spot iron ore reached its 2013 peak of $158.90 a tonne. At that time the six-month contract was only 86 percent of the value of the front-month.
The curve usually trades in mild backwardation and in the past four years a change to steep backwardation, where longer-dated contracts trade at a large discount to short-dated ones, has led to sharp price declines.
From the peak in February, spot iron ore prices crashed 30.5 percent to the year's low of $110.40 a tonne on May 31.
In a March column, I suggested that prices may drop as much as 40 percent, based on the shape of the curve.
This was based on the 37 percent drop in prices between April 21, 2010 and July 13 of that year, when just prior to the decline the six-month contract had been at 84 percent of the value of the front-month.
The easing of the backwardation in the curve recently suggests that future price declines will be more limited, but it's important to note that the conditions for a rally have yet to emerge.
The curve has in the past gone into contango, where near-dated contracts trade at a discount to those with longer maturities, just prior to rallies.
The six-month contract was 9.8 percent higher than the front-month on Sept. 5 last year, just before iron ore staged a 83 percent rally that peaked in February this year.
Futures curves are supposed to be the pricing reflection of the sum total of the market knowledge, so it's worth looking at what the fundamentals are saying about iron ore.
China, which buys about two-thirds of global seaborne iron ore, has yet to experience a marked tailing off in imports of the steel-making ingredient.
Imports were 67.1 million tonnes in April, the third-highest on record, and year-to-date inbound shipments were 3.7 percent higher over the first four months of 2013 compared to the same period last year.
May figures are due next week and could exhibit similar strength, especially in view of a 21 percent jump in iron ore exports from Australia's Port Hedland in May over April.
The jump in exports from the port that handles one-fifth of all seaborne iron ore trade suggests that the running down of inventories in China may well have run its course.
Port inventories in China are currently just under 75 million tonnes, well down on levels close to 100 million tonnes that prevailed in August last year, meaning that there may be a limit to how much more de-stocking is likely.
If the inventory situation is slightly bullish to neutral for iron ore imports, the real concern is in the steel sector.
So far this year steel mills have been increasing output despite mounting signs of slack growth in demand.
Crude steel output was 65.65 million tonnes in April, down slightly from a record high in March, and output for the first four months was 8.4 percent higher than the same period in 2012.
There hasn't been any pullback in May, with data from the China Iron & Steel Association showing daily output of 2.185 million tonnes a day in the 10 days from May 11 to 20, just 0.3 percent below the record achieved the prior 10 days.
But, steel inventories have been rising and were probably 40 percent higher at the end of May than at the end of March.
Steel producers are reluctant to idle output as they don't want to surrender market share, but eventually the likelihood is that higher-cost manufacturers will have little choice.
Baoshan Iron & Steel Group, whose listed unit is China's biggest steelmaker, expects output to rise just 1-2 percent in 2013, down from 3 percent in 2012 and average growth of 10 percent a year between 2006 and 2011.
If this forecast is correct, it implies falling steel output for the rest of 2013, given the first four months saw fairly strong growth.
This in turn is bearish for iron ore, but if prices do fall much from current levels, it's smaller Chinese producers that will face more pressure to idle mines than the low-cost giants, namely Brazil's Vale and the Australian pair of Rio Tinto and BHP Billiton.
Overall, the current market situation and outlook give little reason to expect a rally any time soon in iron ore, or Shanghai steel prices.
While the bias is still to the downside for iron ore prices, the potential losses from the current price are probably limited to $10-15 a tonne.
And finally, China's iron ore imports may surprise with their resilience in coming months as steel-makers prefer cheaper imported supplies over higher-cost domestic output.