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Is the Speculative Frenzy in Iron Ore About to End in China?

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Jun. 9 2016, Updated 11:04 a.m. ET

Speculative frenzy in iron ore

Iron ore prices have increased since the start of the year, despite analysts thinking to the contrary. While fundamentals in terms of Chinese appetite got a boost from the country’s announcement regarding further easing and public spending, most Market participants believed it wasn’t enough to kick-start a rally of this magnitude.

This raised concerns about speculative trading supporting the iron ore price rally in the futures market. Along with prices, volumes for commodities (COMT) also saw an unprecedented rise. This included iron ore, which provided support for this thesis. Credit growth in the Chinese economy remained firm in the first quarter, and returns on most investments were minuscule. But investors poured money into commodity futures to bet on Chinese investments in infrastructure and economic spending.

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Authorities clamp down

This caused Chinese regulators to clamp down on these activities. They tightened rules and raised transaction fees at the Dalian Commodity Exchange, which would curb speculative trading in the futures market.

Fang Xinghai, vice chairman of the China Securities Regulatory Commission (or CSRC), said, “Recently, we experienced huge volatility and trading volumes in some commodity futures.” He added, “We supervised the exchanges to take measures, which have seen a notable effect.”

Impact of the crackdown

These measures have caused some sanity to prevail in the futures market. After rising ~55% since the start of 2016 until April, steel rebar futures prices have retreated ~30%. This shows a corresponding impact on iron ore prices.

The benchmark iron ore price is currently trading near $50 per ton. That’s more in line with the supply-demand fundamentals. In our series Is the Recent Iron Ore Price Rally Sustainable? we saw that a price near $45 per ton is currently reflective of the underlying demand-supply situation.

Having said that, we note that there could be continued volatility in the Market, both on the upside and downside. This could be driven by catalysts such as ramping up of the S11D project from Vale SA (VALE) and Roy Hill. More easing announcements from China could lead to another upward spike.

The crackdown leading to lower prices is negative for iron ore producers such as BHP Billiton (BHP) (BBL), Rio Tinto (RIO), and Cliffs Natural Resources (CLF).

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