Morgan Stanley analysts used this brilliant sketch to explain the commodity rally

It’s been a wild year on commodities markets. Iron ore, in particular, enjoyed a spectacular rally that started in earnest after the Chinese New Year and then continued through April when the price popped briefly above $US70 before crashing back to its current levels back around $US51.

All sorts of reasons have been proferred for the rally: Chinese economic stimulus, the growth of speculative trading in futures contracts, and a spike in demand ahead of a government-mandated shutdown of production to accommodate a flower show in the steel-producing city of Tangshan.

But there are important seasonal realities to commodity markets which Morgan Stanley thinks you should understand, possibly with the aid of this excellent sketch:

Source: Morgan Stanley research

The sketch is included as context to notes from a recent research trip to China, where Morgan Stanley analysts confirmed with producers that the rally in March and April was big restocking after the lull of the Chinese New Year and that the associated rally has run out of puff.

The note, from Brendan Fitzpatrick, Joel Crane, Stefan Hansen and Rahul Anand, notes: “Steel players of Tangshan confirmed it for us … Mar-Apr = big restock. But they’re getting cautious again. Why? Because demand/price upside moderated in May + 2016H2 worries them. Optimal strategy? Destock.”

“So, is the Resources’ re-rate done?” they write. “For 2016, we think it is. Next trade opportunity = Oct-16.”

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