Is This Metals Rally Really Speculative? Would That Be So Bad?

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Over the past few days, several analysts have said the recent metals rally was purely speculative, without a fundamental justification for the price swings. But what’s speculation?

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Speculation is the act of trading an asset, with the risk of losing part of all of the capital invested, in the expectation of a substantial gain. For traders to trigger a price rally there must be a fundamental reason justifying that the risk of loss is more than offset by the possibility of a significant gain; otherwise, there would be very little motivation to speculate. So, in reality, every price movement, especially in commodity markets, is speculative.

Iron Ore and Steel Rebar Prices Fall

Steel and iron-ore futures traded in China have gone into sharp decline, reversing the huge price run-up seen this year. Analysts believe that the rally has retraced because of new measures taken by exchange officials. In late April, Chinese exchanges raised margin requirements on iron ore, hot-rolled coil and steel rebar. That is, they raised the amount that investors need to deposit to trade these assets.

Steel-rebar and iron ore prices year to date

Steel rebar and iron ore prices year to date. Source: Wind Info.

But are higher margins a reason for a price fall? I don’t think so. Higher margins only mean that investors enjoy less leverage, that’s not a justification for a sustainable decline in prices. Higher margins can reduce the volume traded (as investors need to deposit more money per trade) but that doesn’t necessarily cause a change in price direction.

So why did prices fall? The simplest reason is that prices move in a zigzag. Prices went up too fast and they need time to digest those gains. Steel rebar and iron ore prices fell sharply over the past few days, however, the decline comes after a massive run-up. Despite the recent decline, steel rebar and iron ore prices are up 23% and 30% on the year-to-date respectively.

High Market Uncertainty

We agree that prices increased too fast, which justifies the fact buyers are closing positions and sellers come into the market to bet short on overbought levels. However, now that prices have come down significantly, we could see investors supporting prices again. We are witnessing some changes in commodity markets that could favor rising metal prices in the medium/long-term.

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We see high uncertainty in current markets, especially in a period when stimulus measures are driving market sentiment. We don’t see these new exchange rules making this rally vanish, other factors like the value of the U.S dollar or the effect of China’s stimulus will likely determine future price trends. It’s impossible to predict the future with 100% accuracy, but what is possible is to make informative decisions based on current information. With all this market uncertainty, metal buyers would do well to take some risk of the table.

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