Iron Ore And The Baltic Dry Index - Barometers For The Global Economy
- Iron ore has recovered recently.
- Shipping rates continue to languish.
- China holds the key.
- U.S. infrastructure rebuilding couldprovide a spark.
- Three ways to position for a reboundin the industrial sector.
We have seen a rocky road for the prices of industrial commodities since late 2015. Ferrous and nonferrous metals and many dry bulk commodities prices fell to multiyear lows in late 2015 and early 2016. Most of these raw materials fell to significant bottoms and entered into a period of price recovery throughout 2016. Following the U.S. Presidential election, industrial commodities prices exploded to the upside as President Trump ran on a platform that focused on infrastructure rebuilding in the United States. Additionally, the optimism about an increase in economic activity in the U.S. translated into optimism about the prospects for growth China and other nations around the world. On a percentage basis, the gains from the 2015 and early 2016 lows were nothing short of astounding when it comes to many raw material markets. Base metals, including copper, aluminum, nickel, lead, and zinc posted a 26.77% gain in 2016. However, the strong price action in the metals markets could not compare to two other markets that are often barometers for economic growth and activity. In 2016, the price of iron ore gained 110.34%, and the Baltic Dry Shipping Index posted a 102.32% increase on a year-on-year basis.
As optimism has declined over the first six months of 2017 given the roadblocks to legislation in Washington DC, iron ore and the BDI which both more than doubled in price in 2016 have given up part of their gains. As of June 30, iron ore was down 22.54%, and the BDI fell 4.27% so far in 2017. At the same time, base metals are still 4.82% higher than their December 2016 closing prices. Over recent weeks, the price of iron ore has recovered from lows in the middle of June, which could be an omen for other industrial commodities prices.
Iron ore has recovered recently
The price of iron ore more than doubled in 2016 but 2017 has been an entirely different story for the main ingredient in steel. Source: Barchart
As the chart of the August iron ore futures contract shows, the price of the industrial commodity declined from highs of $83.12 on February 21 to lows of $52.63 on June 13. Since the recent lows, the price has bounced back to $62.85 on July 10. Markets tend to overshoot on the up and downside so the recent recovery could just be a move that reflects the current supply and demand fundamentals for iron ore which remains more than $20 per ton below its February highs.
Shipping rates continue to languish
While the price of iron ore has bounced over the past month, shipping rates continue to reflect weakness in industrial commodities demand. Source: BDIY Quote - Baltic Dry Index
As the chart illustrates, the Baltic Dry Index which is a benchmark for shipping rates for dry bulk commodities as moved from 1338 on March 29 to 822 on July 10. The BDI is now trading at the lowest level since February with the 2017 lows at the 688 level. The BDI is a lot closer to the lows than the highs.
China holds the key
China is the world's leading consumer of industrial commodities, and while the recent move in the price of iron ore is a positive signal, the lethargic price action in the BDI is a commentary about the health of the Chinese economy. As the world's most populous nation, it will be economic growth in the Asian nation that will determine the path of least resistance for steel, other industrial raw material prices, and shipping rates in the months ahead.
The selloff in raw material prices that took prices down to multiyear lows in late 2015 and early 2016 was the result of slower Chinese economic growth. While prices may have moved to levels that were too low, the industrial commodities sector was a reflection of conditions facing China at the start of 2016. Right now, iron ore is trading at a price that is $20 below the level seen in February 2017, but it is $20 above the price one year ago. When it comes to the BDI, one year ago the shipping index was $100 lower than its current level. China holds the key to the path of least resistance for the industrial commodities sector, but it was optimism from the United States that sparked rallies from November 2016 through the first months of 2017.
U.S. infrastructure rebuilding could provide a spark
The Trump administration and their Republican colleagues in the two houses of Congress are continuing to work on their first legislative victory since the election. A first victory could lead to tax reform and infrastructure legislation, but we have yet to see a win when it comes to anything but executive orders. Gridlock in Washington is so institutionalized within the system that it has become almost impossible to break. However, if it starts to appear that an infrastructure rebuilding bill could become a reality; the chances are that it would light a fuse on some industrial commodities prices. Optimism that turned to pessimism in February and March could quickly turn around again given a legislative, political victory for the President.
Three ways to position for a rebound in the industrial sector
Iron ore is trading at a price that is the midpoint between the February highs and last year's price at this time of the year. The BDI has dropped sharply since late March but remains higher than last year at this time. There are some signs that these barometers for the global economy are at pointing to the potential for a rebound given the right set of circumstances over coming months.
I believe that there are currently three ways to position for a rebound in the industrial sector. However, given the price action over recent months, I would only look for buy industrial commodities assets during periods of price weakness. In other words, I will be looking to pick up bargains at times when industrial commodities look like they are about to fall off the edge of a bearish cliff.
Oil is one of the most ubiquitous industrial commodities in the world. I am looking to buy oil-related assets on any price weakness over the weeks ahead. Source: Barcharts
The trend in the XLE has been bearish since December 2016, and in many ways, the Energy Select SPDR had been a harbinger for the drop in the price of oil, I am a buyer of the XLE on price dips over coming weeks.
The second opportunity I see over coming weeks would be in the steel sector. It appears that the price of the price of U.S. Steel (X) has found support around the $20 per share level after falling from almost $42 per share in February to lows of $18.55 in May. Source: Barcharts
X has been consolidating and making higher highs since the May lows and could offer an attractive risk-reward profile for those entering long positions on price weakness.
Finally, copper is the one metal that tends to serve as a barometer for the industrial sector. The red metal has been coming off recent highs at just over $2.70 per pound, and it looks like the price is heading back for a test of prices below the $2.60 level. An increase in LME stocks caused copper to reject the $2.70 per pound level, and initial support now stands at $2.5570, the June 21 lows. Critical support for copper is down at $2.4755 on the September COMEX futures contract. When it comes to copper, the JJC ETN product does a reasonable job when it comes to replicating the price action in the red metal. Additionally, stocks of copper producers like FCX and SCCO tend to follow the price of the industrial metal.
I am not bearish on the prices of industrial commodities. Right now, these assets are facing bullish and bearish factors. The weak dollar is supportive for prices, but rising global interest rates increase the cost of carrying inventories and tend to be bearish for prices. I am a buyer of the industrial sector on price weakness and will look to take profits on rebounds while maintaining small core long positions. If the markets become volatile in a range, I will be able to lower the cost of my core long positions to a comfortable level by grinding trading profits.
Benchmark industrial commodities prices are currently higher than they were last year at this time which is a good sign for the global economy. However, the industrial sector is facing bullish and bearish factors that could make trading rather than investing the optimal way to approach these markets and assets that reflect their prices.
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This article was written by
Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.Over the past two decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities.
Andy understands the market in a way many traders can’t imagine. He’s booked vessels, armored cars, and trains to transport and store a broad range of commodities. And he’s worked directly with The United Nations and the legendary trading group Phibro.
Today, Andy remains in close contact with sources around the world and his network of traders.
“I have a vast Rolodex of information in my head… so many bull and bear markets. When something happens, I don’t have to think. I just react. History does tend to repeat itself over and over.”
His friends and mentors include highly regarded energy and precious metals traders, supply line specialists and international shipping companies that give him vast insight into the market.
Andy’s writing and analysis are on many market-based websites including CQG. Andy lectures at colleges and Universities. He also contributes to Traders Magazine. He consults for companies involved in producing and consuming commodities. Andy’s first book How to Make Money with Commodities, published by McGraw-Hill was released in 2013 and has received excellent reviews. Andy held a Series 3 and Series 30 license from the National Futures Association and a collaborator and strategist with hedge funds. Andy is the commodity expert for the website about.com and blogs on his own site dynamiccommodities.com. He is a frequent contributor on Stock News- https://stocknews.com/authors/?author=andrew-hecht
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