Key indicators you should watch out for in the iron ore industry (Part 11 of 11)
What are iron ore futures and why are they important?
A commodity future contract is an agreement to buy or sell a particular amount of commodity at fixed price, on or before a certain date. Buyers use these to avoid the risks associated with price fluctuations and sellers try to lock in prices for their commodities.
Future contracts depict market sentiment and expectation regarding future demand and supply, and therefore prices for a particular commodity. They reflect current market conditions in the future prices.
Investors should keep an eye on future contracts prices and fluctuations to understand the market expectation for future prices.
New York Mercantile exchange iron ore futures are the most liquid iron ore futures contracts that trade on the market. But there are other future contracts as well, like Singapore iron ore futures and Dalian iron ore future contracts.
Iron ore futures are in backwardation right now
The New York Mercantile Exchange iron ore forward curve is in backwardation right now. “Backwardation” means the future contracts are trading below the spot price. This means the market expects a further decline in iron ore prices based on current indicators and fundamentals.
Supply surplus is when low-cost supply additions outpace demand for the world’s largest consumer of iron ore—China, which consumes close to two-thirds of seaborne iron ore. Supply surplus is the main contributor to this backwardation.
In backwardation, the futures curve is downward-sloping. The opposite market condition to backwardation is called “contango.”
Impact on companies
Backwardation in the futures curve shows negative market sentiment regarding future prices. A decline in futures prices is negative for companies like Rio Tinto (RIO), BHP Billiton (BHP), Vale SA (VALE), and Cliffs Natural Resources (CLF) and also ETFs that invest in iron ore companies like the SPDR S&P Metals & Mining ETF (XME).
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