Iron ore in much-needed correction, China futures have more to drop: Russell

24 March 2017

It's taken a while but the iron ore market is finally getting the reality check it needed, although the Chinese part of the market still looks like it requires a bigger dose.

Spot iron ore .IO62-CNI=MB fell to $84.99 a tonne on Wednesday, down 10.4 percent since its peak this year of $94.86, reached on Feb. 21, although it is still up 7.7 percent so far this year.

The most-actively traded iron ore futures contract on the Dalian Commodity Exchange (DCE) fell to 677.5 yuan ($98.37) a tonne on Wednesday, a drop of 6.9 percent since its peak so far this year of 727.5 yuan on Feb. 21.

However, the DCE contract is still up 22.2 percent so far this year, indicating that while it has started to correct, the process still has likely some way to go.

This can be seen by looking at the gap between the spot price for cargoes delivered to China and the DCE price, the latter of which is driven by small investors and day traders who often respond differently than the end-user buyers and sellers that participate in the spot market.

In U.S. dollar terms, the DCE contract was at $105.73 a tonne at its 2017 peak on Feb. 21, a premium of $10.87, or 11.5 percent, to the prevailing spot price.

The premium had actually widened by Wednesday to $13.50 a tonne, or 15.9 percent, showing that while DCE futures have lost some ground, they are lagging well behind the correction in the spot price.

In U.S. dollar terms the DCE contract traded at a discount to the spot price in 2014, 2015 and for most of 2016, flipping only to a premium around August last year, before narrowing to parity by December.

However, the DCE's premium to the spot price has blown out so far this year, giving credence to the view that there was speculative froth in the Chinese domestic market.

It's also worth noting that the current correction in prices is happening without any real change in the underlying narrative of the Chinese iron ore and steel markets.

The outlook for 2017 is still fairly healthy for infrastructure and property in China, although this has been tempered by concern over a possible trade slowdown because of the protectionist leanings of new U.S. President Donald Trump.


On the data front, it appears that China's iron ore imports will be high again in March, continuing their recent strength.

Vessel-tracking and port data compiled by Thomson Reuters Supply Chain and Commodity Forecasts show that an estimated 97.79 million tonnes of iron ore is due to, or has already, arrived at Chinese ports in March.

If the actual number is close to this estimate, it would be a record for monthly imports, and above the customs figures of 83.49 million tonnes in February and 92 million in January.

The vessel-tracking data typically comes in below the customs numbers, but even if the final numbers are below the current estimate, it's still likely that March will be an exceptionally strong month.

The point of concern in the prevailing market narrative is the level of port stockpiles in China SH-TOT-IRONINV, which rose to 131 million tonnes in the week to March 17, up from 113.9 million at the start of this year, and 65 percent above the low of 79.4 million recorded in mid-2015.

The level of inventories has been one factor regularly cited by market analysts as to why iron ore prices must inevitably decline, a process that finally appears to be underway.

While it's always difficult to predict how far prices will drop, it does seem the ongoing correction is likely to be steeper for the DCE futures than for the spot price, and the Singapore Exchange contracts, which are based on the spot assessments.

The SGX futures curve is indicating a price of $65.89 a tonne for the contract expiring in December this year, a level closer to what many analysts would deem fair value.

But a measured decline to those levels would be unusual, given the recent history of price spikes and slumps in iron ore.