Banks muscling in on physical iron ore trading and lured by volume

Thursday, 15 Sep 2011

It is reported that an increasing number of investment banks are poised to muscle into the trading of physical iron ore a business long dominated by trading houses lured by the market’s huge size and its shift to a more transparent pricing system.

Mr Colin Hamilton Macquarie analyst said “The global market volume is a major incentive, the iron ore market dwarfs any other metals and now they have a functioning financial market.”

He said that “The majority of the commodities banks including Macquarie are looking at physical iron ore.”

About 1bn tonnes of sea borne iron ore are traded every year with about 20-30% sold on the spot market and the rest sold in long-term contracts. The banks may never match trading houses in this market, because their risk limits will curb both speculative trading and deals in some risky parts of the world.

Even so banks will build their physical iron ore businesses for several reasons. Involvement in this market will help them to limit risk in their burgeoning iron ore derivatives businesses as well as to forge deals to finance companies in the booming mining business.

Mr Abe Ulusal a trader at Mitsui Bussan Commodities said “Having access to the physical material will give banks more leverage and will limit their risk on the derivatives side.”

After pioneering iron ore derivatives trading, Deutsche Bank started trading physical iron ore in 2010. Other banks such as Citi and Goldman Sachs are now following.

Iron ore swaps trading started in 2008 but began to gain more traction in 2010, when iron ore miners dumped a decades old annual price benchmark system and moved to pricing in the shorter term.

Iron ore swaps allow producers, consumers and financial market participants to hedge or bet on prices in the future.

The volume of swaps cleared on the Singapore Exchange reached a record annualised level of almost 50 million tonnes last month and although it is still small compared with the physical market and it is growing quickly.

(sourced from Gulf-Times)