SGX pioneered the world’s first cleared iron ore swap in 2009. Today, the market has grown to over two billion metric tonnes of futures and options annually, trading at 1.5 times the size of the underlying physical market. As the key ingredient in steel production, iron ore has proven to be an effective proxy for the Chinese, as well as the global macro economy. It has also been one of the best performing major commodities in the world in terms of price and returns over the last few years.
SGX recently announced a partnership with TT to provide free market access for TT platform users who aren’t yet trading iron ore. To help better acquaint our readers with SGX as well as the iron ore market, we took this opportunity to chat with William Chin, Head of Commodities.
Thank you for talking with us today. Let’s start with an introduction. Please tell us about SGX and the iron ore market.
Will: As Asia’s most international, multi-asset exchange, SGX offers trading and risk management solutions across equities, fixed income, currencies and commodities, allowing traders to access all Asia-centric OTC and exchange-traded products from one single location.
When SGX pioneered the world’s first iron ore swaps in 2009, the physical market was then transitioning out of a decades-long annual benchmark pricing mechanism.
As more and more physical participants began utilizing these instruments to hedge their price risks, the SGX iron ore derivatives market grew exponentially, attracting financial investors to also trade these contracts to express views on the macro economy.
Today, the market trades over $1 billion in notional value daily of iron ore contracts on SGX.
Annual volumes of iron ore derivatives have surpassed 2 billion tonnes for the last 2 years. Congratulations on that. What’s driving the continued rise in volumes?
Will: At 2 billion tonnes, derivatives volumes have surpassed the underlying seaborne iron ore physical market. The growing participation comes from across time zones (the market is active for 21 hours a day) and also from diverse participant types.
In particular, iron ore is increasingly seen as a proxy for the Chinese, and perhaps even the global economy due to its importance in steel-making which is critical for infrastructure and real estate development. Thus we have seen a significant increase in participation from the financial sector—funds, PTGs, CTAs, asset managers, etc.—utilizing iron ore as an investment tool.
We have also seen strong growth in our electronic screen activity which today represents about a quarter of our futures volumes. We have market-makers making two-way markets throughout the day, and liquidity has been strong, with volumes currently at 15,000 to 20,000 lots per day.
Liquidity begets liquidity, and we see high potential for further volume growth, given the modest paper-to-physical velocity for iron ore which is currently at less than two times, compared with the 10 to 20 times for traditional metals.
What are your observations about iron ore market fundamentals recently?
Will: On the demand side, iron ore fundamentals continue to be strong. Iron ore, together with coking coal, are the key ingredients in traditional steel making—a production method that uses the blast furnace and accounts for around 80% of steel production today, as compared to producing steel by recycling scrap metal in an electric arc furnace. And by the way, scrap steel as a green raw material is gaining attention and that is a space we are watching closely.
Steel is absolutely fundamental to modern civilisation and urbanization—for example, steel rebar is used to reinforce concrete for construction and rolled steel goes into railroads, as such demand for steel (and thus iron ore) globally will remain strong, especially due to post-pandemic infrastructure-related stimulus. Demand from China, the world’s largest producer of steel, is the key input in the demand equation.
On the supply side, Australia and Brazil are the two main global suppliers of iron ore. A combination of pandemic lockdowns and weather disruptions in both locations has rendered supply somewhat unpredictable. Whilst iron ore prices have traditionally been relatively volatile, it has been particularly so over the last 6-12 months. It breached the $200/MT mark for the first time in history in May-21 but it’s now back at $140/MT.
You mentioned iron ore as a financial instrument. Could you elaborate on that?
Will: Not many may know this, but iron ore is the second largest commodity in the world by annual traded physical weight and value with only oil ahead of it, and it has started to gain in economic importance as a global commodity. Analysts have highlighted how well it serves as a proxy for the Chinese economy, and perhaps even for the global macro-economy, comparing it alongside copper. This has laid the groundwork for increased financial participation—from financial-type clients, and also the way they trade it on the electronic screen as a complementary venue to the OTC market.
The other unique feature of the iron ore futures market is the consistently backwardated nature of its forward curve, which means rolling returns have been consistently attractive. Combine this with it being one of the best performing commodities in recent years, iron ore has indeed gained prominence as an investible asset.
This explains the myriad of financial participants who have been joining and growing the market, where they now make up close to 30% of our iron ore volumes.
What other commodity products are available on SGX?
Will: Besides iron ore, SGX’s suite of commodities derivative contracts includes steel, freight, rubber, coal, oil, petrochemicals and electricity—this product breadth allows physical participants to position themselves against major swings in commodities prices, and also for investors to gain exposure to this very diverse set of underlying commodities that correlates strongly with economic movements.
Another commodity where we see financial participants are increasingly gravitating towards is rubber. Worldwide consumption for natural rubber has increased steadily and the Asian story continues to drive demand for this raw material. SGX’s SICOM rubber contract, which is used extensively by rubber players to hedge price risks, is the global pricing benchmark for the raw material. With the majority of liquidity concentrated in the central limit order book, it is a great instrument for institutional investors and other traders looking to diversify their portfolio and trading strategies, including curve trading and calendar spreads.