Iron ore is looking shaky as futures suddenly plunge

Photo by Romina Amato/Red Bull via Getty Images

After soaring to a fresh four-month high on Thursday, the iron ore rally has taken a turn for the worse today.

Chinese futures are getting slammed, coinciding with a warning from the China Iron and Steel Association (CISA) that recent strength in rebar futures, and as a by-product iron ore prices, was “not driven by market demand or reduced market supply”.

Here’s the scoreboard at the mid-session break on Friday.

SHFE Rebar ¥3,830 , -3.50%
DCE Iron Ore ¥533.50 , -5.16%
DCE Coking Coal ¥1,318.50 , -0.94%
DCE Coke ¥2,160.00 , 0.75%

After closing the overnight session at 567 yuan, the January 2018 iron ore future in Dalian has been smoked, falling over 5% to 533.5 yuan. It hit a high of 587.5 yuan earlier this week, extending its rally from June 14 to 44.3%.

The sudden slide in Dalian mirrors a similarly-large plunge in rebar futures on the Shanghai Futures Exchange.

The January 2018 contract has slumped by 3.5% to 3,830 yuan, extending its decline from 4,016 yuan struck yesterday. Like iron ore futures, it had surged 50% from early June, leaving it sitting at the highest level in over four years.

The chart below shows iron ore and rebar futures since the beginning of the year. Rebar is shown in yellow, iron ore in white.

Source: Thomson Reuters

Recent strength in steel prices, helping to boost margins, had encouraged Chinese steel mills to ramp up production levels, leading to strength in iron ore and coking coal markets.

In June, Chinese crude steel output hit the highest level on record, according to data released by CISA. Despite the surge, rebar inventories continue to sit near the lowest levels since November last year, underlining the strength in domestic demand at present.

“The recent lift in prices largely reflects stronger steel mill margins,” said Vivek Dhar, mining and energy commodities analyst at the Commonwealth Bank. “As long as steel margins remain elevated, the incentive for steel mills is to purchase iron ore to boost steel production in the short term.”

However, despite those fundamental drivers, it seems the warning from CISA, following a meeting with the Ministry of Industry and Information Technology (MIIT), China Securities Regulatory Commission (CSRC) and the Shanghai Futures Exchange (SHFE) earlier this week, has resonated with traders.

“These warnings serve the purpose … to cool down markets or to see some consolidation in commodity prices,” Helen Lau, Argonaut Securities analyst, told Reuters. “We think the government wants to ensure stable development in markets and does not want to see quick boom and bust cycles fuelled by speculation.”

Dhar, too, thinks the latest surge in iron ore prices may have done its dash.

“We believe that iron ore prices have returned to unsustainably high levels, given the strong incentive amongst marginal iron ore producers to boost output,” he says.

“The northern winter months could prove the catalyst for lower iron ore prices as policymakers strictly limit steel production.”

“That should translate through to weaker iron ore demand. But that also assumes that the steel sector adheres to policy, which is increasingly more believable, but still a risk given past behaviour,” he adds.

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