COLUMN-Iron ore swaps backwardation points to price slump: Clyde Russell
--Clyde Russell is a Reuters market analyst. The views expressed are his own.--
By Clyde Russell
LAUNCESTON, Australia, March 4 (Reuters) - Iron ore prices may fall as much as 40 percent in the next six months, given the current shape of the future curve of swaps traded in Singapore.
The curve <0#SGXIOS:> has moved to the steepest backwardation since April 2010, normally a signal that prices are likely to fall.
The curve usually trades in mild backwardation and in the past four years a change to steep backwardation, where longer-dated contracts trade at a large discount to short-dated ones, has led to sharp price declines.
Conversely, a switch to contango, where longer-dated swaps command a premium to those for immediate delivery, has heralded a rally in Asian spot prices <.IO62-CNI=SI>.
The six-month contract on the Singapore Exchange was at $129.83 a tonne and the front-month at $154.60 in early trade on Monday, meaning the six-month is 84 percent of the value of the front-month.
That's the exact same percentage in place on April 21, 2010, when iron ore peaked at $186.50 a tonne before plunging 37 percent to bottom at $117.60 a tonne on July 13 of that year.
It's also a bigger discount than prevailed just before iron ore's slump of 42 percent between April and September last year.
The six-month contract was 95 percent of the front-month on April 13, 2012, when iron ore was at $149.40 a tonne. It then dropped to $86.70 by Sept. 5 last year.
If iron ore prices were to fall as much as they did between April and July of 2010, that implies a decline to around $90 a tonne from the $150.60 close on March 1.
Already prices have been coming off the recent peak of $158.90 a tonne reached on Feb. 20, amid speculation that demand growth may ease in coming months in China, which buys about two-thirds of global seaborne iron ore.
This is based on the view that Chinese steel mills have largely completed re-stocking after running down inventories in the second half of 2012, when the economy experienced slowing growth.
There is also some concern the impact of the stimulus aimed at ending that period of weakness will start to fade by the second half of 2013, thereby limiting demand growth for steel.
This is especially the case if China does act to tighten property controls in a further bid to rein in price increases.
Iron ore is expected to average $125 a tonne this year, the median of a Reuters poll of 17 analysts in January shows.
While this is less than the spot price now, the analysts also expect Chinese imports to rise 5 percent to a record 778 million tonnes in 2013, after rising 8.4 percent last year.
The reason that higher imports won't spur higher prices is the expected increase in supplies in the second half of 2013, as Australian producers bring new projects on line.
Seaborne supply will exceed demand by 20 million tones this year, according to Goldman Sachs, and this will rise to 215 million tonnes by 2016.
The increase in supply and slower growth in demand in China does support the signal of lower prices from the swaps curve.
But there are always risk factors with scope to alter the balance of the iron ore market, and India is a case in point.
The South Asian nation used to be the world's third-largest exporter behind Australia and Brazil, but mining bans and court disputes have seen it virtually disappear from the market.
India used to export as much as 100 million tonnes of the steel-making ingredient a year, but last year managed only 30 million and there is speculation it may even become a net importer in 2013 as steel mills can't source enough at home.
China's domestic output is also an unknown factor as it tends to ramp up when prices are high but idle when they fall.
Even high domestic output doesn't necessarily translate into slower imports as the local iron ore is of poor quality and higher grade ore is still needed.
And there is also the assumption by analysts that miners will produce regardless of price, in other words, all the new supply capacity coming on stream will actually hit the market.
As iron ore is dominated by the big three of Brazil's Vale , and Australia's Rio Tinto and BHP Billiton , it is one of the few commodities in which even mild supply curbs have the potential to boost prices.
It may just be that the big three will prefer to limit output to preserve prices rather than produce as much as they can and bet that their costs are lower than their competitors.
While these factors may keep iron ore prices from sliding too far, the likelihood is still that they will decline in the next few months, as suggested by the increasing backwardation of the swaps curve.
(Editing by Clarence Fernandez)