One of Twiggy Forrest’s recent attacks upon big miners has pivoted around the finaincalisation of iron ore. He has argued that the emergence of Dalian iron ore futures (combined with big miner jawboning) has disconnected the iron ore prices from fundamentals.
Mac Bank today throws up a similar question:
The rally across base metals, oil and iron ore in recent weeks has certainly been aggressive.
However, all of these have a strong financial market influence, whereas those commodities which are set by physical market pricing have seen little movement. Every now and again these disconnects do happen, generally driven by changes in macro views, but how the gap closes is now the more important consideration.
Meanwhile, one of the more noticeable trends in the past month has been the rapid divergence of iron ore and other steelmaking raw materials, such as met coal or manganese ore. At $60/t, iron ore is up 12% from April 16, while both manganese and met coal have sunk to price levels not seen since well before the financial crisis. Without any financial market distortion, the lesser steelmaking raw materials perhaps better reflect the subdued feeling of the global steel industry, given low (if potentially bottoming) prices and relatively weak demand growth. Iron ore is thus the outlier in the ferrous value chain.
True enough and I’d be the first to concede that financialising iron ore was always going to be a double-edged sword. I argued just that in 2009 when BHP broke open the contract system.
The recent sell off was earlier in the year than I expected and the rebound has been bigger, but, really, with China in a hard landing, and with the amount of stimulus now pouring forth, the kind volatility we are seeing is not out of character with past iron ore markets. In 2012 there were similar broad conditions and just as large a swings in the iron ore price and there were no futures in China.
Dalian futures are physical delivery, not free-floating synthetics with nothing but speculation to drive them, so although they have likely increased the speed of transmission from information to price, and short term volatility has increased as such, I’m not sure they have actually changed the amplitude of price swings over the cycle.
While a commodity is locked into such a bear market, we should expect price discovery to be pretty wild at times. As the glut slowly but surely finds its equilibrium at the lowest marginal cost of production volatility will subside.
