China outlook is key as crude oil and iron ore prices diverge
Historically, crude oil and iron ore prices are strongly correlated, which is unsurprising given they are both commodities tied to the state of the global economy. But in recent weeks the link has largely been severed.
Crude oil has trended weaker since Brent futures nearly touched $100 a barrel early in November, while spot iron ore for delivery to north China has surged higher.
Brent futures reached an intraday high of $99.56 a barrel on Nov. 7, but then dropped 25% to a low of $75.11 on Dec. 9.
Spot 62% iron ore, as assessed by commodity price reporting agency Argus, jumped 42% from a close of $79 a tonne on Oct. 31 to finish at $112.15 on Dec. 9.
The divergence was maintained during Monday’s trade, even though the direction changed, with Brent gaining 4.1% to close at $78.18 a barrel, while iron ore shed 1.8% to close at %110.15 a tonne.
Notwithstanding the small change in fortunes at the beginning of this week, the trend for the past weeks has been weaker crude and stronger iron ore.
The questions are what are these two key commodities are telling us about the state of the world economy and whether their divergence is justified or participants in one are calling the outlook incorrectly.
The first point to note is that iron ore is much more of a China story than anything else, given that the world’s second-biggest economy buys about two-thirds of all seaborne volumes of the steel raw material.
While China is also the world’s largest crude importer, its share of seaborne volumes in that market is closer to 20% of the global total.
Iron ore’s rally is largely a function of the market view that Beijing will successfully stimulate its sluggish economy, boosting demand for steel as the residential property sector recovers in the new year.
This sentiment has been further boosted by China’s relaxation of its strict zero-COVID policies, which had crimped economic growth and led to mounting public dissatisfaction with restrictions on everyday life.
It’s likely that Monday’s decline in iron ore was linked to the sharp increase in COVID-19 cases in China and some signs the medical system may be struggling to cope.
Any sign that Beijing will reverse its easing of COVID-19 measures will undermine the bullish view of China’s economy for the first quarter of next year.
Conversely, if the authorities stick to the current re-opening plan and manage to weather the increase in hospitalisations, it will be viewed as an economic positive, notwithstanding the accompanying increase in sickness and deaths.
CRUDE DEMAND WORRIES
Crude oil’s declining trend has been somewhat linked to China, as the market has fretted over the state of demand, given the earlier COVID-19 restrictions.
While these worries have eased and China appears determined to boost its economy, concerns about demand in the rest of the world have overtaken optimism over China’s re-opening.
A global economic slowdown is likely to cut crude oil demand, possibly by as much as 2 million barrels per day (bpd), or roughly 2% of daily demand.
The price has also declined as the market has taken a view that the Group of Seven nations’ price cap on Russia’s exports and the European Union’s ban on imports from Russia are unlikely to have much of an impact on global supply.
Rather it appears that Russia has been able to divert much of its crude to buyers in Asia, mainly China and India, although logistical and financial constraints may lead to lower export volumes for several months.
The overall point is that the signals from the crude oil and iron ore markets can both be correct and contradict each other at the same time.
Iron ore’s rally does appear justified by Beijing’s concrete steps to stimulate growth in steel-intensive sectors and by the easing of pandemic restrictions.
Crude oil’s decline was justified by rising concern over a global economic slowdown and the weakening of fears of a Russia-led supply crunch.
What remains to be determined is whether China’s re-opening will be enough to keep iron ore prices strong, and also if it’s enough to lift crude oil as well.
Source: Reuters (Writing by Clyde Russell; Editing by Bradley Perrett)