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Monday, February 7, 2011

Iron ore futures can be efficient

The report, "BHP, Vale Move to Quarterly Iron-ore Pricing System,"which came early this year indicated that the move by two of world's largest miners to dump the four-decade old iron ore pricing mechanism signify a tectonic shift in the global markets.

While steel is world's most profoundly used metal, iron-ore resides at the heart of the global steel industry, being the primary ingredient in steel making.

Like the demand for food, world consumption of steel continues to grow unaffected by even the previous financial crisis during the last five years with a CAGR of 2.5% on the back of low per capita consumption in emerging economies. With rapid information flow into the markets and growing transparency, no wonder BHP and Vale had decided to opt for rewards while agreeing to take risks, on the back of run-away demand for ore.

As about half of our iron-ore production is being exported, there is no way the Indian iron-ore markets participated by a relatively larger number of buyers and sellers can remain insulated from this development.This is bound to keep iron ore prices in the Indian markets highly volatile largely to the benefit of intermediaries at the cost of India's competitiveness in iron ore/value added products and realization by the miners.

Historically, iron-ore prices were fixed through the obscure method of annual negotiation between mining majors and steel producers. Though iron-ore is globally abundant and widely extracted, given the capital intensive nature of its production and transportation, supply augmentation takes a longer time.

Iron-ore supplies remained restricted due to little incentive to augment supply on prices locked for a year, Besides, long-term contracts for most commodities are almost a history, possibly enticing iron-ore miners to shift to shorter-duration pricing mechanism which can better reflect the dynamics of market fundamentals.

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