The surge in iron ore futures prices on April 17th, with the 2409 contract breaking through 870 during trading, can be explained from the following perspectives:
Capital Overflow: As mentioned in the previous article "Iron Ore: New Pricing Factors," the recent rise in iron ore prices has been driven by new, industry-external factors, namely funds hedging against currency fluctuations in precious metals and non-ferrous metals, flowing into iron ore. This week, the exchanges further fueled this change: On April 16th, the Shanghai Futures Exchange adjusted the hedging trading margin ratio for copper and aluminum futures contracts to 8%, and for speculative trading to 9%; it also increased the transaction fees for nickel, tin, and silver futures. This further ignited the iron ore market. With relatively low valuation and priced in USD, iron ore has become the preferred target for capital overflow.
Steel Mill Recovery Cycle, Difficulty in Controlling Raw Material Prices:
Over the past two years, during the recovery cycle of steel mills, the increase in raw material prices has been greater than that of steel prices. Currently, pig iron production is rebounding month-on-month, although it remains at a low level compared to last year, it is still on the path of recovery, which is a positive factor. However, the price surge of raw materials, whether it's coking coal, coke, or iron ore, has made it difficult for steel mills to resume production. Currently, steel mill inventories of coke and iron ore are low, and with steel mills in the midst of the production recovery cycle, resuming production is relatively inflexible. Therefore, it is currently very difficult for steel mills. On one hand, downstream steel demand has slightly improved, inventories have finally been reduced to some extent, but on the other hand, raw material prices have skyrocketed. Since other steel mills have resumed production, one cannot afford to lose market share and can only grit their teeth and resume production. In this way, the money is all being earned by upstream raw materials.
The future trend can be inferred from the previous two points.
Firstly, the pressure for depreciation on the Renminbi still exists, which will cause the overall valuation center of iron ore to rise. However, the significant influx of funds has already priced in the depreciation to some extent. Currently, the basis of the 2409 contract is at historically low levels, indicating that even iron ore is significantly overvalued. If funds continue to flock to iron ore, the low basis may attract traders and other spot players to enter the market for short hedging. A further decrease in the basis or even the appearance of delivery profits would present a good opportunity for traders at ports where profits are inverted. If spot goods are sold cheaply at the port while the market prices are high, traders could sell goods on the market, earn delivery profits, or lock in profits.
Secondly, negative feedback factors are also brewing. The recent sharp rise in raw material prices has eroded the hard-earned profits of steel mills. Moreover, there are currently few bright spots in downstream demand. At this point in time, steel mills are indeed in a very difficult situation, having to resume production with low bargaining power. However, by the end of April or early May, before the May Day holiday, when steel mills have replenished their raw material inventories and if downstream demand remains mediocre, steel mills may slow down production and avoid being bottlenecked by raw materials. This situation may pose a risk of negative feedback.
Therefore, it's advisable to remain cautious and observe the market trend for now. Continuously pursuing long positions carries significant risks, given the low basis and fragile fundamentals. Shorting would require waiting for further accumulation of contradictions in the industry chain, especially towards the end of April when steel mills have completed replenishing their inventories. At that point, the strong momentum of raw materials may change.
