After tumultuous few years, commodity price have enjoyed a rare moment in the sun in 2016. A weaker US dollar and renewed optimism over the outlook for China’s economy, along with great swathes of short covering as traders unwound bearish bets, have led to some impressive gains in recent months.
In Australia, the enormous surge in the iron ore price has received plenty of attention. From the lows struck last year, the spot price for benchmark 62% fines has soared by 43.8% according to pricing from Metal Bulletin, resulting in iron ore posting the largest percentage gain of all major commodities so far this year.
Any number of factors have been hypothesised to explain the amazing rally.
Increased construction activity in China, hopes for higher prices on the back of China’s push to restructure its enormous mining sector and even speculation over a scheduled flower show bringing forward steel production before a government-enforced curtailment have all been presented as factors to explain the sudden, and largely unexpected, bounce.
While they could be responsible for the renewed optimism towards iron ore, Robert Rennie, global head of market strategy at Westpac, believes another factor could be behind the recent rally — an increase in speculative buying.
“I see signs of increased speculative activity as playing an important role in this recent bounce in commodities, especially in iron ore,” says Rennie.
He points to the chart below to justify his view, and on the evidence presented, it suggests something unusual is afoot. It tracks the equivalent metric tonnes of iron ore traded in futures on the Dalian Commodities Exchange, going back to when Chinese iron ore futures first started trading in late 2013.
“On several days over the last couple of weeks, Dalian has traded just over 9 million contracts. On the 10th of March, just over 10 million contracts traded. Each contract is based on 100 metric tonnes. That means that futures contracts on the 10th March turned over the equivalent of 1.045 billion tonnes of iron ore, well above the amount that China imported in the last year,” notes Rennie
“The average daily volume trade in the last 20 days stands at the equivalent of 620 million metric tonnes per day. In March last year, that number was just 94 million tonnes. I suggested recently that Chinese day traders were hard at work speculating about fiscal policy and new works programs, pushing iron ore sharply higher.”
“Rightly or wrongly, I think there is a lot to be said for the idea that the move higher in iron ore indices has been driven at least in part by speculation rather than fundamentals.”
Going off the chart below tracking the spot price for benchmark 62% fines, it’s noteworthy that the sharp pick-up in the iron ore price occurred at the same time futures trading volumes surged.
It could be fundamentals, it could be optimism towards an increase in Chinese fiscal spending, but it could also be a sign that speculative investors have moved into commodity futures trading, pushing prices higher as was the case in China’s stock and property markets beforehand.
Whatever the reason, the physical market has already responded to the sharp lift in the iron ore price with a growing number of marginal mines restarting production in recent weeks.
To Rennie, this is what the global iron ore market should be watching closely, be they producers, buyers, mining shareholders or taxi drivers in Shanghai.
He explains the impact that the recent price lift has had on the supply side of the market.
A good example is African exports to China. Exports from Sierra Leone disappeared last year as the Tonkolili mine was closed. China’s state-owned Shandong Iron and Steel Group bought the mine in April last year. It re-commenced operations in February of this year. This should mean that production/ exports from Sierra Leone should continue to rise. The Ngwenya iron ore mine in Swaziland looks like it is re-opening. Cliff’s Natural Resources announced recently that it will be restarting its iron ore pellet production in Minnesota. Last month, the Indian government announced it will drop the 10% tax on fines of grades with 58% content or less and abolish the 30% levy on lower-grade lumps.
Along with the recommencement of production from marginal producers, seen in the chart below, and an increase in production in Australia and Brazil as major mining projects ramp up seaborne supply, Rennie remains unconvinced over the merits of the current price surge.
“It’s not clear to me that there is a compelling argument for the commodity price trend being different,” he says.
For the moment, the wild swing in iron ore futures persist.
As a case in point, the May 2016 contract on the Dalian Exchange currently sits up close to 2% in late trade on Wednesday, mirroring the 2% gain seen on China’s benchmark stock index, the Shanghai Composite.
It’s a subjective view, and others may disagree, but when you see iron ore mirroring gains in stocks on a regular basis, you have to wonder what factors are currently driving the market.