TOKYO -- Heavy Chinese speculation is roiling the iron ore market, with the upturn in futures trading leading to volatile spot rates.
The spot price of Australian ore headed to China surged above $70 per ton at the end of April, up more than 60% from the end of 2015. Plans revealed at China's National People's Congress in March for transport infrastructure investment of more than 2 trillion yuan ($306 billion) per year caused prices of rebar and other steel materials to skyrocket. Ripples then spread through the Asian market overall, raising prices of products such as hot-coil steel.
A sense that the steel market had found a bottom stirred anticipation of a recovery in demand for iron ore -- a basic material in steel production -- sending prices soaring in the futures market. Retail investors flooded into the Dalian Commodity Exchange. Trading on some days in late April exceeded the amount of ore China imports in a year, underscoring the gap between real demand and speculative fervor.
China has toughened restrictions on equities investment in the wake of 2015's Shanghai stock market crash. "Speculators are now shifting their funds to the commodities market, targeting products such as iron ore that are expected to rise in price," Jiro Iokibe of Daiwa Securities said.
Many of China's once-unprofitable steelmakers have moved to resume operations as steel product prices have recovered. That group includes so-called zombie enterprises -- loss-making companies Beijing has targeted for elimination in order to trim national crude-steel production capacity by between 100 million tons and 150 million tons by 2020.
Authorities have scrambled to impose greater restrictions on futures trading, raising margin requirements and service fees to discourage speculation. Retail investors and other players particularly unhappy with stricter regulation are now selling, bringing the spot price of ore back below $60, 10% lower than at the end of April.
Many in the market expect gains in iron ore prices to be limited going forward, given that China has yet to begin earnest efforts to adjust steel output. Large-scale production set to launch in Brazil in the second half of 2016 makes a reduction of the current supply glut unlikely. Goldman Sachs sees the spot market's recovery as a short-term phenomenon, forecasting an average price of $35 per ton in 2017.
Speculation is effectively turning iron ore into a fluid financial instrument. "In China, futures prices could become an industry benchmark, if they start to have a greater impact on real ore prices," Naohiro Niimura of Market Risk Advisory said.
The prices major steelmakers such as Nippon Steel & Sumitomo Metal pay Australian resource producers for ore are set quarterly, based on a three-month average of spot prices. Shipments for the April-June quarter marked the ninth straight period in which contract prices declined. But that downward trend will likely end in the upcoming quarter. Companies will need to find ways to stabilize shifting procurement costs going forward.