Welcome to the club! Iron ore joins the elite circle of globally traded commodities
Every now and again a new kid on the block will join the elite circle of commodities, recognised and traded worldwide. Now viewed by many as the second most important commodity behind oil, the rise of iron ore has mirrored the transformation of China.
The rise of Iron ore has been rapid and has mirrored China’s transformation
Iron ore has been one of the least volatile commodities of 2020 and has even outperformed mining equities and metals, which over the course of the last few years has been relatively flat, while the S&P (GCSI) index has more than tripled.
The recent rise of iron ore has been quite spectacular, around ten years ago the magnetic red dirt was viewed as an opaque market with negotiations often being taken annually inside smokey rooms with Japanese businessmen and more recently China.
There are several characteristics that make the iron ore market distinctive as an investable asset. Supply is concentrated in a handful of geographic regions, most notably Australia and Brazil and is controlled by only a small number of participants, while Global demand is dictated by one big end-user, China.
Geopolitical events can cause shock to both supply and demand, natural disasters, COVID-19, political events and also the actions of individual asset owners.
Platts IODEX is the main prevailing benchmark price and this represents medium grade iron ore with roughly a 62% iron content, and that has recently broken through the $100 a tonne mark, mainly in part to rising steel prices, strong steel maker profit margins and increased demand out of China.
The unique characteristics of iron ore present opportunities for investors, as a liquid and easily accessible proxy for Chinese economic growth or, more specifically, the performance of the Chinese manufacturing and infrastructure sectors.
In the past, the majority of market participants were exposed to iron ore through purchasing the stock of metals and mining companies. There are some issues that occur by going down this route. Just a handful of companies are focused on iron ore due to the high costs associated with producing it. These companies are not pure-play iron ore equities, with the percentage dedicated to iron ranging from 30% to 60% of their businesses.
The creation of the iron ore futures by SGX and DCE and the S&P GSCI Iron Ore index has allowed market participants to gain direct exposure to iron ore, and improved liquidity and price transparency in derivative markets.
The physical iron ore market has gained in transparency over recent years, spot market activity is deep, with transactions accounting for 12–15% of total market size, according to S&P Global Platts price reporting data.
In many ways, iron ore is still a very traditional physical supply chain, both in its inherent set-up and attitudes. The length of trading chains, often seen as a barometer of commoditization and market maturity, is still rather short in iron ore, with most cargoes only changing hands once or twice, compared with up to 15 times in some energy markets.
Further, a reluctance of iron ore producers to openly bid or offer material has stifled the evolution towards a more efficient, liquid and transparent market, as occurs in other more mature commodity markets such as oil. This hesitancy is said to stem from fears of an outcry from steelmakers claiming this could in some way amount to abuse by the miners. Yet, it is worth noting that Chinese steelmakers routinely openly sell in the market.
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