A steel worker operates a furnace at a plant in Hefei, Anhui province, last July. The price of iron ore is largely dependant on the sentiment of medium-sized Chinese steel mills -- the marginal buyers of the commodity on the spot market.JIANAN YU
Jack Farchy writes for beyondbrics, the FT's emerging markets hub
Move over, Dr. Copper. There's a new pseudo-academic commodity in town: meet Professor Iron Ore.
The bulk commodity, the key raw material in steel making, has been catching the interest of hedge funds with its precipitous 30 per cent drop so far in October. With copper moving ever more closely in line with the broader equity markets, iron ore has acquired a small following as the macro trade of choice.
The rationale is simple: demand for iron ore is tightly linked to global industrial production, with a focus on China -- just like copper. Unlike copper, however, iron ore has no futures market and so is less impacted by the day-to-day vagaries of financial market sentiment.
Instead, the price of iron ore is largely dependant on the sentiment of medium-sized Chinese steel mills -- the marginal buyers of the commodity on the spot market. As such, the iron ore market offers an excellent indicator of sentiment in Chinese heavy industry -- particularly the construction industry.
Of course, just like dear old Dr. Copper, Prof. Iron Ore has his flaws.
The fall in the spot price in the past month has undoubtedly been exacerbated by the fact that the market pricing mechanism is still in a state of flux. Most contracts for the current quarter were set at prices well above the current spot market, meaning that steel makers have an incentive to refuse to take their contracted cargoes, forcing miners to sell them on the spot market and so push prices down further.
Nonetheless, a growing number of investors are watching Prof. Iron Ore closely, especially for his insights on China.
Indeed, some mining executives believe the differential between high-grade iron ore "lump" and lower-grade "fines", which tends to widen when the market is tight and steel mills are running full tilt, is the best indicator of the state of the Chinese economy (certainly preferable to the official statistics).
The fact that the spread has collapsed from $20-$25 earlier this year to close to zero in the spot market currently, while prices have dropped from $183 in early September to $120 now, is an indicator of how sentiment in China has shifted in the past month or so.
For early students of Prof. Iron Ore, the fall has been very profitable. Some macro hedge funds have made a handsome profit betting on a fall in prices via the swaps market - helping to send volumes of iron ore swaps cleared on the SGX to new records. (There have been several days in October when more than 750,000 tonnes of iron ore was cleared - compared to a previous monthly record of 6.6 million tonnes, according to The Steel Index.)
Amid all this doom and gloom, though, there is a chink of light. Buyers have been appearing in the swaps market, especially for longer-dated contracts: calendar 2014 iron ore swaps were up nearly 5 per cent on Thursday. If that rebound follows through into the physical market, it will be a clear sign - for Prof. Iron Ore's most diligent students at least - of a turning point for the global economy.