Whenever a government, particularly a communist one, doesn’t like certain market characteristics or trends, the ‘speculator’ is always on hand to take the blame.
This week began with the Chinese authorities, nervous about the record high iron ore prices, issuing various pronouncements and threats to ‘speculators’ in time-honoured fashion.
Whether there really is a major clique of iron ore speculators in existence is an open question. Time was, and not too long ago either, that the iron ore price was agreed in advance between buyers and sellers, and the understanding was that it would be held at that level until the next agreement took force.
That way of doing things died a death during the early part of the mining boom of the first decade of the current millennium, as Chinese demand simply rocketed away and a system of open-market pricing became the easiest way for the rising economic superpower to secure supply.
Back then, China was a new player.
Now though, it’s established as the number one buyer of several of the world’s most widely produced commodities, including iron ore and copper.
So if it’s unhappy with the way certain commodities are being priced, whether due to the influence of ‘speculators’ or no, it matters.
The iron ore price duly fell significantly once the Chinese dissatisfaction became known, partly because the Chinese threats have put the opportunity costs up a bit, but also because of worries that with the price so high, perhaps China won’t buy at all, or will buy less.
After all, those who produce iron ore, both in terms of countries like Australia, Brazil and South Africa, and in terms of companies like VALE (NYSE:VALE), BHP (LON:BHP)(ASX:BHP) and Rio Tinto (LON:RIO), are pretty much beholden to China for the maintenance of the high prices that we are currently witnessing, and by extension of demand in general.
As a centrally-controlled economy, China can in theory shut down iron imports at a stroke and attempt to ramp up its own domestic production instead. Such things were tried in the Great Leap Forward, and from the point of view of central planning, were deemed not to be successful. But Chinese know-how has increased exponentially since those days, not just in terms of the production of commodities, but also in terms of its understanding of the markets in which they are sold.
So, the question arises: if the Chinese suddenly say they that from now on they will be buying iron ore at a price fixed at a significant discount to spot on a given day, will the iron ore producers be able to resist?
The answer to that isn’t immediately clear. China’s economic growth might take a significant hit if it were deliberately to curtail iron ore imports. But a country that runs a command and control economy by definition is likely to care more about command and control than growth. Will the major iron ore companies take the risk if they are presented with such an ultimatum? If the profits and margins are still there, perhaps some significant discount for their largest customer are, after all, in order. A face-saving way forward might be a return to something like the old price-setting structure. But it might be a bumpy ride getting there.