Fundamentals, not regulation, to drive iron ore lower

  • While China’s announcement that it will crack down on speculation and market irregularities has taken some of the froth out of the iron ore market in recent weeks, we think the price of iron ore will ultimately be driven even lower by less favourable fundamentals over the rest of the year.
  • There is some evidence to suggest that speculation in China has contributed to the recent increase in the price of iron ore. Although strong demand and disruptions to supply have been the primary factors driving it up from around $80 per tonne to over $200 over the last 12 months, a marked rise in trading volumes over the last month has coincided with the latest surge in the price. (See Chart 1.)
  • However, over the last week or so, the price of iron ore has dropped back following rumours that authorities in China would examine market manipulation and crack down on speculation. Then, on Monday, the price of the 1-month iron ore contract at China’s Dalian Commodity Exchange fell by a further 7% in response to a warning from the Chinese government to key enterprises that they should “actively fulfil their social responsibilities” and help “maintain market order”.
  • However, while the government’s actions look to have taken a bit of the froth out of the iron ore market in the near term, history suggests that they won’t have much of an influence in the longer term.
  • In December last year, the market regulator in China imposed a trading limit on iron ore futures that led to a dramatic decline in volumes, which cooled the rally in prices for a few weeks. However, the rally has since resumed and prices increased by another 40% or so by mid-May on the back of strong demand from steel producers, despite trading volumes remaining well below 2020 levels.
  • What’s more, while tighter regulation in response to surging prices and speculation in 2016 successfully led to a collapse in trading volumes and brought prices back down initially, favourable fundamentals including a revival in steel output drove the price higher again a few months later. (See Chart 2.)
  • Accordingly, we doubt that this current crackdown on speculation will have much of an effect on the price of iron ore over the months ahead. However, in contrast to the examples above, we think that market fundamentals point to the iron ore price falling further before the end of 2021.
  • On the supply side, Brazil’s iron ore exports are returning close to the levels seen before the Brumadinho dam collapse, and domestic production in China surged in March and April. Furthermore, while stocks of iron ore held at Chinese ports have been drawn down slightly over the past month, they are still nowhere near the levels that would be consistent with the current iron ore price. Meanwhile the withdrawal of policy stimulus in China, which will probably be felt hardest in the construction sector, should weigh on demand.
  • As a result, we expect the price of iron ore to drop back to around $140 per tonne by end-2021, and $120 per tonne by end-2022 as the market shifts into a surplus.

Chart 1: Iron Ore Price & Trading Volumes (2021)

Chart 2: Iron Ore Price & Trading Volumes (2016)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


Adam Hoyes, Assistant Economist, adam.hoyes@capitaleconomics.com

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