Here's a primer on the Dalian Commodity Exchange, China's market for everything from iron ore to eggs

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The Dalian Commodity Exchange has been around since 1992 but its increasing levels of activity have had it becoming a more frequent feature of market chatter.

Business Insider now regularly covers activity on the DCE, particularly in regard to the futures prices for bulk commodities like coking coal and iron ore. The DCE covers a vast array of commodities beyond those, however.

Among the less familiar commodities traded on the DCE, you’ll find:

  • Polypropylene
  • Palm oil futures
  • Eggs
  • Fiberboard
  • Soybean
  • Soybean meal
  • Soybean oil
  • Genetically modified soybeans
  • Soybean meal options futures (coming March 31)
  • Rice
  • Corn

How the market actually works remains little understood, however. In a research note, UBS analysts have attempted to set that straight.

Commencing in 1992 in the north-east Chinese city of Dalian, the DCE started off as an agricultural commodities exchange before expanding into industrials (coking coal and iron ore) in 2013. It now has almost half a million market participants, but only around 2% of those are corporate accounts.

“In 2015, the DCE was ranked 8th out of the leading global derivatives exchanges by the Futures Industry Association”, said UBS.

This chart shows the rapid increase in the volume of futures contracts (in millions) since iron ore was included:

According to UBS, “In 2016 the accumulative trading volume of iron ore reached 34.227 billion tonnes, with a daily trading volume of 1,402,700 contracts and a daily open interest of up to 871,000 contracts”.

As this next chart shows, the volume of iron ore trade made up 23% of all contracts entered into on the DCE in 2016.

The number of participants in the market for iron ore futures on the DCE now numbers 477,200, with the majority being retail traders. There are 11,605 corporate accounts, representing just over 2% of the total, but they have a higher degree of market share, accounting for 28% of contracts and 34% of open interest.

Although this relative market share gives corporate accounts some power in the market, the bulk of volume is still driven by retail traders.

As is common on commodities exchanges, the volume of contracts being traded far exceeds the physical volume of iron ore that changes hands. According to UBS, just 3.2 million tonnes of iron ore was physically delivered.

Typically volume spikes into the hundreds of millions of tonnes towards the end of a contract, but the vast majority of contracts close out before delivery. This chart demonstrates the movement:

Currently, only companies with a Chinese domicile are able to trade on the exchange. The prevailing view is that will likely change and as the iron ore futures market continues to grow, the DCE will be opened up to global iron ore companies and steel mills.

“The iron ore futures market is still relatively new and as confidence grows it has the potential to expand significantly”, said UBS.

The DCE has proven a happy hunting ground for iron ore speculators, with many using the market as a hedging mechanism. To avoid abuses the DCE has taken measures to crack down on rampant speculators.

According to UBS, “these measures include banning individuals from trading its futures, increasing the minimum trading margin and decreasing the daily price limit”.

Since the addition of iron ore futures on the DCE, the exchange has revealed an almost direct correlation between futures contracts and the iron ore spot price.

“From the iron ore futures product launch in 2013 to the end of 2016, the correlation between the iron ore futures price and the spot price was 0.99”, the UBS analysts said.

Prices on the DCE exchange are also consistent with the major iron ore indexes and futures traded in Singapore, as seen here:

Platts, Bloomberg, UBS

The chart above also clearly illustrates the strong rise in iron ore prices over the last year.

According to UBS, “the DCE is looking towards a strong future outlook with rising contract prices and increasing volume along with a general trend towards increasing open interest; all indicating a strong economic performance”.

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