The Dalian effect? Benchmark iron ore price slides to 3-month low

The price of iron ore sunk to a three-month low on Wednesday as traders assess the impact of the launch of a new Chinese futures contract in the steelmaking raw material.

The benchmark CFR import price of 62% iron ore fines at China's Tianjin declined slightly $131.20 a tonne on Wednesday to a level last seen at the beginning of August according to data provided by SteelIndex, which has been tracking the price since November 2008.

The commodity is still up some 19% from its 2013 lows struck at the end of May as fears of a sharp economic slowdown in number one consumer China recede and the impact of new supply are discounted (for now at least).

Iron ore's retreat in October has been a slow and steady affair compared to the $60 plunge recorded during October 2011 and a similarly dramatic pullback in August last year and the decline in the benchmark contrasts to the fall in the newly-launched iron ore futures contract on China's Dalian Commodity Exchange.

The first domestic Chinese iron ore futures contract which DCE launched less than two weeks ago fell to its lowest level since trading began. On Wednesday the most active May delivery futures changed hands at 916 yuan before settling at 922 yuan after an almost 5% drop during the first week of trading.

Volumes on the exchange have been brisk. Initial volumes equivalent to 15 million tonnes have now quietened down to closer to 5m tonnes, but still compares well to the 1–2 million tonnes worth of futures traded on the Singapore exchange.

Citi released a research note on the Dalian iron future saying that interest in physical arbitrage between the Dalian contract and non-customs cleared ore as tracked by SteelIndex is high and that trading of iron ore futures in Singapore have already been boosted.

"Differences in treatment of alumina and Fe content provide additional opportunities even beyond normal arbitrage trading," notes the investment bank adding that there are problems with the contract however:

The lack of a cap on water content presents a danger that undesirable ore will be delivered, impairing the utility of the exchange as a physical market mechanism.

MacroBusiness speculates that "Dalian futures could encourage a further drawdown in the steel mills iron ore inventory levels over time and perhaps mitigate stocking cycles without exposing them to the whim of the Australian cartel."

"In an environment of expected supply increases that will drag the price lower more smoothly but not necessarily more quickly," the Australian blog argues.