A recent article by the Financial Times suggested iron ore is taking over as the bellwether of industrial activity, a role that copper has traditionally served, and epitomized by the well-used phrase Dr. Copper.
The case for iron ore is that with no futures market, it responds less to the speculative influences that can drive short-term copper price movements and more to the underlying direction of the economy. Of late, copper has tracked equities markets, the complete opposite of the mid-decade enthusiasm for commodities that they were supposed to be a counter-cyclical bet responding to long-term supply and demand drivers rather than short-term speculative pressure.
Clearly that thinking proved to be flawed, but will the idea that iron ore is a better measure of industrial activity prove to be any better? And if it is, what does it tells us about China, the country most involved in the seaborne iron ore market?
As if we all needed reminding, China is the main driver of the seaborne iron ore price due to its overwhelmingly dominant position as largest consumer. Growth in China’s imports has been inexorable, but China’s steel companies do not all buy — and hence, influence the market — in the same way.
The major steel firms tend to buy on contract (up to 2008/9, on annual contracts), but when prices collapsed, that regime was replaced by quarterly pricing, based on a three-month average of spot price quotations for the period ending one month before the new quarter. The recent collapse in the spot price has meant major steel producers are paying way over the spot price for current deliveries, somewhere around $175/ton, which has resulted in widespread complaints, cancellations and shipments being delayed.
As shipments are delayed or canceled, miners have sold the cargoes on the spot market, depressing the spot price further. Medium-size Chinese steel mills that tend to buy more on spot have also reduced purchases, waiting for prices to fall further, and exacerbated the decline to $116.75/ton at the end of October.
The iron-ore-as-industrial-activity-indicator camp took this as evidence that China was slowing fast and probably headed for a hard landing. In fact, a number of factors have probably contributed to the speed and depth of the fall, only part of which is down to a gradually cooling rate of growth.
Continued in Part Two.