A Look at Iron Ore Prices

What can iron ore prices tell you? Iron ore prices tend to track economic events (even more so than most commodity prices due to the lack of exchange-traded spot and future prices) and therefore aren’t particularly useful for predicting forward-looking equity markets. But there are still some interesting points to be observed.

When iron ore prices have turned down in response to recent economic events, they typically have fallen until reaching their bottom with no counter moves (see red circles on Exhibit 1). Once iron ore prices turn back up, it has historically been a reliable bottom for iron ore demand.

One reason this relationship may exist is simply the nature of steel blast furnaces. Blast furnaces are extremely inefficient when run at low capacity. Therefore, firms often run a blast furnace at near-full capacity or not at all. For example, while a firm may state it’s running its steel production at roughly 70% of capacity today, it’s in fact running most of its mills at over 90% of capacity and has temporarily shut the rest. Most large firms in this industry operate similarly.

Spot Iron Ore Prices (Including Freight)

Source: Bloomberg

As a result, when an economic slowdown causes a large chunk of equally competitive mills to become unprofitable, they all typically fully shut down, causing iron ore demand to plummet to a new equilibrium. Under such a scenario, iron ore demand does not significantly pick up until real demand forces firms to re-start some mills.

Head fakes may be extremely rare because it is extremely costly and time intensive to stop and re-start a blast furnace, meaning firms will wait until they are confident in the necessity before turning furnaces back on. The fact iron ore’s a bulk commodity also means it’s difficult to opportunistically store meaningful inventory. (Try stockpiling a million tons of anything.) This reduces the effects of speculative inventory accumulation on the iron ore market, making it a great indicator of actual demand.

In my view, the trend likely holds again in this period. And if iron ore prices have begun a strong upswing, that’s seemingly more confirmation of real economic activity improving.