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* Australia sees big iron ore price drop coming
* Threat to recovery in mining profits
* Price rally unsustainable
By James Regan
SYDNEY, Jan 9 (Reuters) - Australia has forecast a steep decline in the price of iron ore, its most valuable export commodity, calling an end to an unexpected rally fuelled by strong demand from China.
The forecast average price in 2017 of around $52 a tonne - down from about $80 a tonne at present - comes as big miners are set to report bumper profits in coming months, while smaller rivals are still getting back on their feet.
"If the iron ore price starts to go down the high performance of last year won't be replicated this year," said Shaw & Partners mining analyst Peter O'Connor. "It could be a trainwreck for the smaller, marginal producers."
In a closely watched release, Australia's Department of Industry, Innovation and Science on Monday predicted iron ore to average just $51.60 a tonne this year, easing further to $46.70 in 2018.
The 2017 forecast was still up from its previous estimate of $44.10, reflecting last year's rally, and broadly in line with major banks on doubts that China's industrial growth will continue to support 1 billion tonnes of annual iron ore imports.
A Reuters poll in mid-December put the average price of iron ore at $54.70 per tonne in 2017, while Barclays expects prices to tumble as low as $50 a tonne by the third quarter of 2017.
Iron ore has already recoiled by 9 percent since mid-December after rising by 81 percent over 2016.
The Australian forecast put last year's price lift down to a temporary rise in Chinese steel output and run-ups caused by speculative commodities trading in China.
"The rally reflects a combination of fundamental drivers and speculative trading," the department said in its latest commodities outlook paper, "However, with the likely moderation of these factors over the outlook period, the iron ore price is still forecast to decline."
Nev Power, chief executive of Australia's third-biggest iron ore miner Fortescue Metals Group and a vocal critic of speculative iron ore trading, said the market was largely in supply and demand balance throughout 2016.
"It is very difficult to predict the iron ore price, however it has remained in a fairly consistent band of around $40-$60 for the past 18 months," Power told Reuters.
"We expect that to continue through 2017 and remain confident in both the short and long-term fundamentals of the Chinese market," he said.
Australia also lowered its forecast for exports of iron ore by 2 percent to 832.2 million tonnes in fiscal 2016-17 from 851 million previously, although this is still a 5.9 percent rise year-on-year. Australia is the world's top supplier of iron ore.
December iron ore shipments to China from Australia's Port Hedland terminal hit a record 37.4 million tonnes in December.
Analysts expect Rio Tinto, BHP Billiton and Fortescue, which together control 70 percent of world iron ore trade, to report sharply stronger profits next month after iron ore prices raced up 80 percent in 2016.
Smaller miners such as Atlas Iron are just now recovering after iron ore fell as low as $38 a tonne last year. (Reporting by James Regan; Editing by Richard Pullin)