How trading iron ore is like the used car business

Jason West, associate professor at Griffith University, writing for The Conversation argues that the global iron ore trade is not dissimilar to buying and selling second hand cars.

With used cars  the previous owner and to a lesser extent the dealer have insights into the real state of the vehicle.

The prospective buyer has the least information.

In the same way the iron ore industry is an example of 'asymmetric information' at work writes West:

The dominant iron ore producers desire a floating price index for iron ore that reflects global steel demand. But they also want to sell iron ore directly to steel producers, and avoid pesky brokers, traders and speculators in between. These intermediaries are regarded by the producers as market parasites latching on to their hugger-mugger marketplace to undercut prices and destroy value.

A floating index is only effective if such intermediaries are present and are freely allowed to trade. Traded volumes of iron ore barely reach 80% of the total global volume of iron ore produced. This is better than zero, as it was prior to 2008. But compared with copper and other metals, whose traded volumes in futures and other derivatives often exceed 100 times their production volume, the iron ore market is stale. The iron ore price index relies upon buyers and sellers to report their transactions to a data compiler, and only a few transactions are ever reported. This is unlikely to improve.

An efficient market is regarded as one where prices reflect prevailing demand and supply conditions. There will naturally be price volatility. Prices for copper or bananas are generally seen as the squiggly line of a random walk and contain inherent volatility, with some price jumps. In contrast, iron ore prices exhibit a volatility all of their own and are capricious in a different way. Instead of a large number of minor price changes with a few large price jumps reflective of normal market activity, iron ore prices are not continuous and mostly only jump up or down. Sometimes the prices changes are quite extreme, taking the market by surprise even though this type of behaviour is expected in a market with limited trades.

This is largely a function of the commodity itself. Iron ore is sold in large parcels to buyers and supply interruptions can trigger price changes as demand spikes. But critically, the fact that the dominant producers have elbowed speculators out of the market, while reluctantly acknowledging their necessity to maintain market liquidity, has created a volatile iron ore price index of questionable relevance to market observers.

Continue reading at The Conversation