What are iron ore futures and how do you trade them?

Iron ore futures have experienced a rough 2022, falling amid declining demand from China. Find out everything you need to know about iron ore before you take a position.

What is iron ore?

Iron ore is the rock from which metallic iron is extracted. By using various industrial processes, companies can process iron ore and create ‘pig iron’ – the main material used to make steel. Roughly 98% of mined iron ore is used in steel production.

Iron ore is one of the world’s most important commodities, due to the high demand for steel across engineering and construction.

What is iron ore trading?

Iron ore trading is the practice of speculating on the price of iron ore in order to make a profit – usually via futures, options, spot prices, contracts for difference, or via shares and exchange-traded funds (ETFs).

As with other derivatives, the aim of iron ore trading is to predict the direction the market will move. The further the market moves in the direction you’ve predicted, the more you’d profit and the more it moves against you, the higher your losses.

Traders might be bullish on iron ore if there’s an optimistic outlook on economic growth and GDP, which usually leads to increased industrial activity and demand for steel.

On the flipside, in periods of economic contraction and slowing demand for iron ore, traders might be bearish on the market price.

What affects iron ore prices?

The price of iron ore is driven by factors that impact supply and demand for the raw material. It’s important to understand all the different market drivers as they can cause significant volatility and risk to your positions.

Economic prospects

When economic prospects are good, demand for steel from construction, infrastructure and industrial development projects can push up the market price of iron ore if supply isn’t increased too.

Conversely, when economic activity is more subdued, the demand for steel may fall and push the iron ore price down.

For example, China’s weakening growth and looming recessions across Europe led ratings agency Fitch Ratings to cut its average iron ore price performance forecast for 2022 and 2023.

Global GDP growth is highly correlated with steel consumption, so data releases are closely watched by iron ore traders – especially GDP from emerging economies that have a larger need for steel amid urbanisation projects.

Housing markets

Steel is used widely in housing construction due to its strength, ability to bind to concrete and cost-effectiveness compared to other metals.

When an economy is growing and there’s an increase in housing starts, the increased demand can push up the price of the raw material if there’s not an increase in the production of iron ore too.

Supply issues

Supply issues can take many forms. Throughout 2022, the most pervasive supply chain issue came in the form of the ongoing Russian invasion of Ukraine. Both Russia and Ukraine have heavy involvement in the market – Russia produces around 6.5 million mt/month of steel, most of which was shipped through Ukraine, while Ukraine produces 1.8 million mt/month. The conflict caused European markets to feel the squeeze as less iron ore was making it out of Ukraine.

What are iron ore futures?

Iron ore futures are contracts in which two parties agree to buy or sell the commodity at a set price on a set date of expiry. On that date, the traders either have to exchange the amount of iron ore, settle the position in cash or roll the contract to the next expiry date.

Iron ore futures are primarily used by large-scale commercial businesses and commodity producers as a means of hedging prices. Hedgers will be looking to maximise the value of their assets by using futures contracts to buy or sell iron ore at a more advantageous price and minimise the risk of loss.

For example, if an iron ore producer thought the price would fall in the next month, they’d enter a futures contract to sell iron ore at the current market price, so that if the market falls, they’re able to earn a profit by selling at the higher price.

Iron ore futures are traded on exchanges such as the Commodity Exchange (COMEX) and London Metal Exchange (LME). All iron ore futures will be regulated to ensure the quantity and quality are standardised to facilitate fair trading.

Iron ore futures contracts specification