Iron ore is imploding, and futures suggest Budget forecasts are already starting to look wobbly

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The spot iron ore price was hammered on Monday, falling by over 5%.

That followed the lead provided by Chinese futures, which closed down 6%, the maximum daily amount the contract can fall.

According to Metal Bulletin, the spot price for benchmark 62% fines fell by 5.7%, or $3.30, to $54.99 a tonne, the third largest percentage decline this year.

From April 21 the price has now fallen by 22%, trimming its year to date gain to 26.2%.

The catalyst for the decline was a move from the Dalian Commodities Exchange (DCE) to quell speculation in commodity futures trading, including iron ore.

The exchange said on Monday it would continue to strengthen its market monitoring and may raise transaction fees further to curb speculation risks.

In response to a surge in speculative activity seen earlier this year, the Shanghai Futures Exchange increased transaction fees in late April while the Dalian Commodity Exchange raised margin requirements and tightened rules on what it called “abnormal trading”.

The announcement from the DCE came shortly before the start of trade on Monday, and saw the most actively traded September 2016 iron ore futures contract swing from a gain of over 3% to a limit down loss of 6% in the space of two hours.

The scale of the reversal, and the speed, provides a glimpse as to the degree of speculation currently evident in Chinese commodity futures trading.

It also suggests that those same speculative forces have infiltrated the physical iron ore market, particularly given the spot price is now strongly correlated with movements in the futures market.

Not only does this raise concerns over the fundamentals that have underpinned the iron ore rally this year, it also raises questions over forecasts offered by the government suggesting that the spot FOB price would average $55 a tonne in the upcoming fiscal year.

The FOB price, or free on board, excludes transport costs, differentiating it from the figure presented by Metal Bulletin which includes transport costs.

The spot FOB iron ore price is now around $5 below treasury’s forecasts, just one week after the release of the federal budget.

In that document, treasury warned that “a key risk to the nominal GDP forecast is the volatility and uncertainty around movements in commodity prices,” adding “the inherent uncertainty around both supply and demand factors means the outlook for the price of iron ore is subject to considerable risk”.

Based on sensitivity analysis conducted by treasury, it calculated that a US$10 per tonne reduction in the average iron ore price — leaving it at $45 a tonne — would result in a $6.1 billion reduction in nominal GDP in the 2016/17 fiscal year.

While those forecasts are premised around an average price, not one daily movement, at its present level it’s already halfway to that level.

And it looks like the spot price is going to sink even lower on Tuesday, at least according to futures pricing.

Iron ore futures tanked 4.34% in overnight trade, mirroring a similar declines in coking coal futures — another key steel making ingredient.

Rebar futures — the end product — fell by 6.6% on the Shanghai Futures Exchange, demonstrating the unwind of speculative positioning that is currently under way across the bulk commodity market.

Trade in all three contracts will resume at 11am AEST. Unless there’s a recovery during the session, the recent correlation between futures and physical markets suggests there’s likely be another significant decline in the spot iron ore price on Tuesday.

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