COLUMN-Tale of two iron ore curves: Which to believe? – by Clyde Russell (Reuters U.S. – May 26, 2014)

Clyde Russell is a Reuters columnist. The views expressed are his own.

LAUNCESTON, Australia, May 26 (Reuters) – Iron ore swaps traded in Singapore are suggesting that the worst may be over for the steelmaking ingredient, but futures in the Chinese city of Dalian point to further price weakness.

Both can’t be correct, but the divergence of the two contracts does raise the question as to which group of investors has a more accurate gauge on the current balance of risks.

The Singapore Exchange (SGX) iron ore swaps <0#SGXIOS:> tend to be favoured by miners and traders, while the Dalian Commodity Exchange (DCE) futures <0#DCIO:> are mainly used by Chinese steel mills and domestic investors.

The SGX iron ore swaps curve tends to move into backwardation prior to a price decline, reversing the process ahead of a rally by moving into contango.

The shape of the current SGX curve is extremely mild backwardation from the second month onwards, with the second-month contract priced at $97.25 a tonne early on Monday, the six-month at $96.58 and the 12-month at $97.

Spot iron ore .IO62-CNI=SI has been on a downtrend since Dec. 4 last year, when it fetched $139.70 a tonne. At that time the SGX curve was steeply in backwardation, with the second-month contract at $137.56, the six-month at $127.50 and the 12-month at $118.88.

The curve was last in significant contango in early June 2013, just as iron ore started a rally that saw it move from about $110 a tonne to a peak of $142.80 on Aug. 14 of that year.

So, the current shape of the SGX curve doesn’t yet imply an imminent rally as it is still backwardated, even if ever so slightly, but it also doesn’t imply further price declines given the backwardation has almost disappeared in recent weeks.

The DCE iron ore contract, launched in October last year, has a shorter history, but it has quickly attracted volumes and the second-month future’s open interest was 2,108 lots as of May 23.

Over its history it has tended to trade mainly in backwardation, but this is hardly surprising given that spot iron ore has been declining since early December last year.

Currently the DCE curve is steeply backwardated at the front end, easing slightly further out.

The backwardation at the front end of the curve is currently the steepest in the short history of the product, illustrating the point that DCE investors are probably more bearish on iron ore now than at any time during the past six months.

The second-month contract was at 769 yuan ($123.43) a tonne on May 23, a premium of 8.7 percent to the six-month.

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