Dalian iron ore futures start with bang

Iron ore futures have begun trading in China with a bang, with turnover on the Dalian Futures Exchange totalling over 21mt in its first 2 days.  This is ~7 times larger than trading of iron ore on the other most active exchange in the SGX.

Not only have volumes on the Dalian exchange have been much bigger than the SGX, there has been some interesting trends in relative liquidity and pricing on different parts of the curve.

The Dalian exchange currently offers contracts for next year starting from March until September. By far the most actively traded contract is for May delivery, which when excluding VAT is pricing at $135/t.

The SGX contracts, on the other hand, have seen the most liquidity in the front months of the curve. As the chart shows left, turnover has lifted dramatically in the last 18 months or so. Daily data would suggest most of this activity is at the short end of the curve rather than for longer dated contracts.

Consider that in its first day of trading, turnover on the May 2014 contract on the Dalian exchange was ~15mt.  On the SGX it was only 60kt, pricing at ~$122/t .

Neither of these prices could be deemed a more accurate reflection of what prices are likely to be by May next year.  Futures don't represent a forecast.  But the huge gap between the two curves suggests there is an arbitrage opportunity between the two exchanges.

Part of the difficulty in narrowing this gap is that Dalian futures are physically settled and it may be difficult for a foreign company to settle these futures in China.  Likewise, Chinese traders may have similar difficulty settling on the SGX.

But if these frictions didn't exist, its likely this gap would narrow fairly quickly. And given the relative trading volumes, it seems likely that the SGX futures would go up rather than Dalian prices go down.

For producers, the main game is still against the spot index, which has crept up a little since the end of Golden Week to $134.40/t. I would imagine that many would be interested in hedging tonnes on the Dalian exchange at these prices, although its likely to be baby-steps for many in the market given spot pricing is a relatively new phenomenon.