Since Chinese markets returned from Golden Week holidays in early October, it’s been nothing but one-way traffic for the iron ore price, mirroring enormous gains in other bulk commodities such as coking coal.
It’s been an almighty rally.
Over October, the benchmark spot price for 62% fines jumped by 15%, with that form continuing into November with prices jumping by a further 1.5% on Tuesday.
It now sits at a six-month high, and has added 50% year to date.
While no one can dispute that the price action in recent weeks has been nothing short of exuberant, there is one question that, as yet, remains unanswered.
Why are prices ripping higher?
Any number of theories have been put forward: optimism towards the outlook for Chinese steel production, the rally in coking coal prices, another key steel input, and improved industrial data out of China just to name three.
However, while these may have been a contributing factor, Goldman Sachs’ commodities research team of Hui Shan, Amber Cai and Christian Lelong, believe there has been another, more dominant, factor at play — weakness in the Chinese yuan, spurring investor demand within China for dollar-linked assets, including iron ore.
“Such desire may become particularly strong whenever the pace of CNY depreciation picks up,” the trio wrote in research note released on Tuesday. “In fact, onshore commodities prices increased across the board on October 25 after the USD/CNY moved higher for three consecutive days.”
Essentially, with an abundance of capital floating around and few US dollar assets to invest in, people have been buying iron ore futures to hedge against further weakening in the yuan.
Not exactly fundamentals, but there’s evidence this is happening.
This flow of capital can be seen in iron ore futures volumes traded on the Dalian Commodities Exchange, as seen in the chart below from Goldman. As the yuan weakened, volumes have picked up, continuing the relationship of previous months.
This, to Shan, Cai and Lelong, suggests that weakness in the yuan, rather than other reasons, has been the main factor that’s driven the rally in iron ore, whether in spot or futures markets.
“By our estimates, about 60% of the iron ore price rally in October can be explained by the CNY depreciation,” the trio said.
And they believe that factor may continue to support prices for sometime yet.
“Going forward, we see further room for CNY depreciation given the high likelihood of Fed hiking in December,” they wrote.
“With ample onshore money supply chasing a limited menu of accessible dollar-linked assets, continued CNY depreciation means that iron ore prices may stay above what the fundamental demand and supply suggest in coming months.”