(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, May 26 (Reuters) - Now that the speculative bubble is over, what next for iron ore?
The Chinese authorities seem to have succeeded in scaring off the retail investment crowd that swarmed into commodities in March and April.
Trading volumes in overheating contracts such as iron ore on the Dalian Exchange and steel on the Shanghai Futures Exchange have collapsed. So too have prices.
The price of spot iron ore .IO62-CNI=SI is now back at $49.90 per tonne, compared with an April 21 peak of $68.70, when the speculative frenzy was at its most acute.
It is, however, still comfortably above the December low of $37.00, attesting to a more positive underlying dynamic in the iron ore market in the form of renewed Chinese stimulus and reduced sea-borne supply.
Neither phenomenon, however, is expected to last. Indeed, the animal spirits behind the price spikes may well have transferred irrational exuberance to China's giant steel sector, which is showing every sign of once again producing too much relative to demand.
That promises trouble ahead, both in terms of China's increasingly controversial export flows and the potential for one of those violent destock events that has roiled iron ore prices in the past.
Higher iron ore prices, meanwhile, have also temporarily derailed the displacement of higher-cost supply necessary to bring the market back into medium-term balance.
This, however, amounts to no more than a lull in hostilities before the battle for survival resumes with renewed intensity.
The iron ore price has benefited from positive changes on both the demand and supply sides of the equation.
It is now clear that Beijing engineered a mini stimulus over the first quarter of this year, using the tried and trusted levers of construction and infrastructure to boost flagging growth.
That stimulus has reinvigorated the steel supply chain in China with production hitting a record 844.6 million tonnes annualised in April.
There are already signs, however, that policy makers are removing the punch-bowl with both money supply and total social financing, the broadest measure of liquidity in the economy, slowing in April.
The fear is that too much steel capacity has been reactivated and there are already warning signs in the form of steel product inventories, which were declining rapidly but have now stabilised.
The other driver of stronger iron ore prices has been reduced supply.
Production by the "Big Three" - namely Rio Tinto, BHP Billiton and Brazil's Vale - grew by just 1.7 percent year-on-year in the first quarter of this year, a sharp braking from growth of 8.4 percent in the fourth quarter of last year.
Bad weather in Australia, a seasonal phenomenon in the iron ore market, has been compounded by the cessation of mining at Samarco in Brazil after November's catastrophic tailings dam failure.
Both BHP and Rio have trimmed their production guidance for 2016 by around 10 million tonnes each, while a timetable for a resumption of operations at Samarco remains uncertain.
The relief afforded to iron ore prices, however, is likely to be short-lived. All three producers are still committed to lifting output in the medium term.
Other producers, meanwhile, seem to have seized on this year's higher iron ore price to maximise output.
Chinese iron ore producers have been on the front line of the battle for survival, so it's worth noting that national production rose by 2.3 percent in April.
The official production figures leave a lot to be desired but the change of trend after three months of year-on-year contraction is significant, a sure sign that the speculative spike in prices has been transmitted into the physical supply chain.
And not just in China.
April's import figures showed rising shipments from the likes of Sierra Leone, Kazakhstan and Iran, higher-cost producers that had been supplying ever decreasing amounts of material at last year's low prices.
India, meanwhile, has also re-emerged as a major iron ore supplier. April's imports of 1.3 million tonnes were the highest monthly tally since February 2014. That reflects the gradual easing of the mining and export restrictions that effectively removed India from the sea-borne iron ore market over the last couple of years.
The percentage of China's imports coming from Brazil and Australia, a proxy for the war between higher- and lower-cost producers, dropped to 80 percent in April, the lowest ratio since December 2014.
Even with renewed buying appetite from China steel mills, the country is struggling to absorb supply, witness the rise in port inventories SH-TOT-IRONINV above 100 million tonnes for the first time in a year.
The surprisingly bullish turn of events so far this year has bought embattled iron ore producers a bit more time.
But the big ones have merely spent that time preparing for a resumption of the last-man-standing war of attrition, from which only the leanest and meanest will emerge.
The scale of cost-cutting in the sector has "surprised us", according to Andrew Mackenzie, BHP chief executive officer, speaking at an industry conference in Miami earlier this month.
But he went on to warn that "some appear to be approaching the limits of what is possible given apparent geological, geographic or scale constraints".
"As a result we believe productivity will become a greater differentiator in the future."
BHP, already one of the lowest-cost producers in the world, is targeting unit cash costs at its Western Australian operations of just $14 per tonne.
The stated aim is to "reduce costs faster and more profoundly than our peers" and, ominously for even other low-cost operators, to "steepen the gradient of the cost curve in the bottom quartile".
And if that sounds a bellicose challenge to everyone else, it is.
The recent strength in the iron ore price has deferred the timing of the next battle but the war of attrition is going to resume sooner or later.
Editing by Susan Thomas