Lost Price: What Iron Ore Prices Tell Us About Where Crude Oil Is Headed

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com.

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By Alex Kimani - Dec 14, 2022, 7:00 PM CST

Historically crude oil and iron ore prices are strongly correlated.
In the last couple of weeks there has been a disconnect with crude prices falling and iron ore prices seeing a strong recovery.
The Chinese zero-covid policy has been destructive for both commodities, but iron ore has made a stronger comeback as measures get eased.

Historically, the prices of two of the world’s biggest commodities, crude oil and iron ore, are strongly correlated, which is hardly surprising given that they are the lifeblood of the global economy including in the transport, industrial production and construction sectors. However, the past few weeks has seen a peculiar disconnect with crude prices declining and iron ore prices enjoying a massive rally. Indeed, Brent futures hit an intraday high of $99.56 a barrel on Nov. 7, but then dropped 25% to a low of $75.11 on Dec. 9. Meanwhile, spot iron ore 62% FE, as assessed by commodity price reporting agency Argus, jumped 42% from $79 a tonne on Oct. 31 to $112.15 on Dec. 9.

The trajectories for the two commodities have lately reversed with crude oil prices gaining about 5% over the past week and iron ore prices declining about 1%, still not big enough of a change to establish a new trend. According to Clyde Russell, Asia Commodities and Energy Columnist at Reuters, events happening in China are responsible for the ongoing disconnect.

Source: Reuters

Unraveling the mystery of Monday’s decline in iron ore, Russell attributes it–most likely–to the steep increase in COVID-19 cases in China and indications that the country’s healthcare system is floundering.

In recent history, iron ore prices have increased more typically on any news suggesting that Beijing might be able to stimulate its economy, boosting demand for steel as the residential property sector recovers, Russell noted.

China is both the world’s largest producer and also the world's largest consumer of steel, with the Middle Kingdom buying about two-thirds of all seaborne volumes of the steel raw material. Hordes of Chinese cities have lately been rolling out measures to boost housing demand, with Beijing keen to arrest a property crisis.

Various local governments have issued at least 70 property easing measures after the Politburo called for efforts from local governments to defuse the property crisis, including cutting the minimum down payment ratio and asking parents to extend a helping hand to their children with home purchases by taking out equity on their own homes.

China’s $2.4 trillion new-home market has shown little sign of recovery, with the economy barely expanded in the second quarter. Meanwhile, mortgage boycotts by homebuyers waiting for apartments to be completed have damped consumer confidence, putting further pressure on home prices, which have now fallen for 11 straight months. UBS estimates the new policies could contribute more than 1 trillion yuan ($142 billion) in fresh financing to the struggling industry. Real estate, contributing roughly a quarter of China’s $17 trillion of output, is a speculative monster that has cannibalized capital better used for other endeavors–a big reason why President Xi Jinping has been reluctant to bail it out despite the cost.

Meanwhile, Beijing’s zero-Covid policy has been blamed for falling crude prices.

It’s been almost three long years since China implemented its hyper strict pandemic control policies, imposing consistent lockdowns nationwide, closing borders, and conducting mass-scale COVID-19 tests to contain the spread of the virus.

With Chinese leader Xi Jinping granted an unprecedented third term as president, the zero-COVID policy appeared cemented in stone. Just a couple of months after reopening the economy, the main districts of Chinese tech hub Shenzhen were forced to go back into lockdown, extended curbs on public activities, and shut down public transport as cities across China continued to battle fresh COVID-19 outbreaks that have dampened the outlook for economic recovery. Beijing handed down orders that residents in six districts comprising the majority of the city’s population of 18 million be tested twice for Covid-19, and workers were forced to work from home.

But the situation took an unexpected turn last week after Beijing announced the most sweeping changes to its strict Covid-19 guidelines, including relaxing testing requirements and travel restrictions. Further, people infected with Covid-19 but have only mild or no symptoms are now allowed to isolate at home instead of convalescing in centrally managed facilities. This week, Beijing doubled down and announced plans to stop tracking some travel on Monday, potentially reducing the likelihood people will be forced into quarantine for visiting COVID-19 hot spots.

These developments have been positive on energy markets, with both gas and oil prices rallying since Beijing did an about-face on Covid-19. The reopening of China, coupled with Russia’s struggle to find buyers for its oil, could see oil top $100 in 2023, UBS analysts said on Monday.

By Alex Kimani for Oilprice.com

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