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The rollout of several stimulus measures by the US government to help the economy recover following the fallout of the Covid-19 pandemic, including various monetary and fiscal policies, had caused inflation expectations to rise in the middle of 2020. These were further bolstered following news that US President Joe Biden had signed a $1.9 trillion coronavirus relief packaged on March 11.
Market sources said the rising inflation expectations were an indication of investor confidence in the economic recovery, leading to bullish markets for commodities such as copper and iron ore.
For instance, the daily official cash price for copper on London Metal Exchange reached a seven-year high of $9,614.50 per tonne on February 25. This compares with $7,918.50 per tonne on January 4, the first trading day of 2021.
Meanwhile, Fastmarkets’ iron ore index for 62% Fe fines, cfr Qingdao reached an a nine-year high on March 4 at $177.98 per tonne, while the index for 65% Fe Brazil-origin fines, cfr Qingdao reached its highest ever at $202.90 per tonne on the same day.
Analysis done by Fastmarkets found that the yearly correlation between the 10-Year Breakeven Inflation Rate, a well-recognized inflation expectation level from US Federal Reserve Bank of St. Louis, and the LME official daily copper cash price was positive and higher in most cases than the yearly correlation between the 10-Year Breakeven Inflation Rate and Fastmarkets’ iron ore indices for 62% Fe fines cfr Qingdao (MB62) and 65% Fe Brazil-origin fines cfr Qingdao (MB65).
What’s the difference between copper and iron ore? A trading source in Singapore said copper has better liquidity in the global market compared with iron ore, and that it has more financial characteristics in it. As a result, the macroeconomic environment typically has more of an effect on copper.
Iron ore is similar but to a lesser extent, the trader said. Iron ore prices remain linked to the macroeconomic environment even though market fundamentals are mostly driven by the world’s largest consumer China and mining majors in Australia and Brazil.
“The seaborne iron ore market is priced in US dollars, similar to LME copper, so when the macroeconomic environment such as inflation expectations change, the US dollar will react to it. As a result, iron ore prices will be affected, but not as much as copper,” he said.
Further correlation relationship analysis was conducted by Fastmarkets based on the Dynamic Conditional Correlation-Generalized Autoregressive Conditional Heteroskedasticity (DCC-GARCH) model after the logarithm returns of LME official daily copper cash price, MB62 and MB65 indicated stationary characteristics for the time series.
An indication closer to one or minus one suggests a stronger correlation while those closer to zero suggest a weaker correlation.
Fastmarkets found that the dynamic conditional correlation (DCC) between LME copper and inflation expectations fluctuated around 0.2. This is significantly higher than the DCC of around 0.024 and 0.037 respectively between the MB62 and MB65 and inflation expectations, which was in line with market participants’ expectation that the rising inflation could have more impact on copper prices than the iron ore prices.
But the results in iron ore also showed a positive DCC despite a weaker correlation compared with copper’s results.
Policy impact on iron ore Market sources said policy impact on iron ore is larger than that for copper, considering stable fundamentals for both commodities.
A trading source in Shanghai said emission restriction policies in China this year, such as those in Tangshan, and a long-term crude steel production cuts had depressed iron ore demand, resulting in significant price volatility.
The never-before-seen measures meted out by China’s Tangshan municipal government in March could cut hundreds of thousands of tonnes per day in steel output and hit raw material demand in 2021.
“The inflation expectations could affect the iron ore prices as well but the impact is not expected to be significant,” the Shanghai-based trader source said.
“However, the emissions restrictions have massively depressed the trading sentiment in the iron ore market, resulting in weak demand, especially for low-grade fines, and less trading volumes compared with previous months despite the increased inflation expectations having persisted over a longer period,” he added.
High-grade iron ore vs mid-grade iron ore High-grade iron ore fines could also be more sensitive to inflation expectations, market sources said.
Fastmarkets found the DCC result of the MB65 fluctuated around a level over 0.036, which was higher than the level of the MB62 by around 50%.
A buyer source in southern China said high-grade iron ore such as iron ore concentrate and pellets were largely consumed by steelmakers outside of China, so such a product would be more sensitive to macroeconomic indicators such as inflation expectations.
“Mid-grade iron ore is mostly consumed in China, so iron ore fundamentals and Chinese policies are key factors for the prices. High-grade iron ore is more internationalized financially, so inflation expectations of the US dollar have more impact,” a trading source in southern China said Sentiment mixed on long-term iron ore prices Sentiment about iron ore prices in 2021 remains a mixed bag.
A second trading source in Shanghai believes the restrictions policies in China will push up demand in high-grade iron ore.
“The recent spread between the 65% Fe swap contract and 62% Fe swap contract on the Singapore Exchange widened to more than $30 per tonne, and healthy steelmaking margins have encouraged mills to use more high-grade iron ore and support prices,” he said.
“With environmentally-friendly capacities expected to start up and more transportation of iron ore to take place on railways compared with roads, demand will gradually recover, so iron ore prices may not fall much in 2021,” he added.
But a second trading source in southern China shared his concerns about iron ore demand in 2021.
“More and more environment protection policies are expected in the long term, and there concerns about whether other regions in China will have similar restriction policies to meet crude steel reduction goals. Hence, the usage in ferrous scrap is expected to increase, which could dampen iron ore prices in 2021,” he told Fastmarkets.