Goldman Says Sagging Yuan, Not Coal, Behind Iron Ore’s Rally

(Bloomberg) -- Iron ore’s eye-catching rally to the highest since April is probably due to the weakening of the yuan, according to Goldman Sachs Group Inc., which said that China’s currency may decline further against the dollar and help to sustain prices of the raw material.

Prices surged last month as losses in the yuan prompted some local investors to move into dollar-linked assets, including iron ore, analysts Hui Shan, Amber Cai and Christian Lelong said in a report received Wednesday. Should the Federal Reserve raise interest rates by the end of the year, there’s scope for further yuan weakness, they wrote in the Nov. 1 note.

Iron ore has rallied even as signs of robust supply multiply, including a buildup in stockpiles at ports in China. While some analysts have sought to explain the jump by pointing to higher coal prices as a driver, Goldman said that didn’t stack up as a reason, targeting the yuan’s drop instead. The Chinese currency has sagged as local policy makers signaled they are willing to allow greater currency flexibility amid a slump in exports and rise in the dollar.

“By our estimates, about 60 percent of the iron ore price rally in October can be explained by the yuan depreciation,” the analysts said. Iron ore may be the first in line to benefit from onshore investment flows into commodities as the “futures curve is almost always backwardated, making long iron ore a positive-carry trade,” they said, referring to bets on gains.

Futures on the Dalian Commodity Exchange jumped 24 percent in October, while the contract in Singapore surged 14 percent last month. On Wednesday, spot ore with 62 percent content was at $65.31 a dry ton after reaching $65.33 a day earlier, which was the highest since April, according to Metal Bulletin Ltd.

‘Stay Above’

“Given the large money supply in China and the limited onshore dollar-linked investment options, further yuan depreciation may cause iron ore prices to stay above what fundamental supply and demand suggest in the near term,” the Goldman analysts wrote.

In Shanghai’s spot market, the yuan lost 4 percent this year in Asia’s worst performance. The currency, which fell to a six-year low last week, was at 6.7645 a dollar on Wednesday. The exchange rate is “approaching 6.8, pushing onshore investors to diversify into dollar-linked assets,” Goldman said.

While iron ore prices rallied in October, so too did stockpiles sitting at ports in China, the world’s largest buyer. The holdings expanded to 106.75 million tons as of Oct. 28, the highest level since November 2014, according to data from Shanghai Steelhome Information Technology Co.

To contact the reporter on this story: Jasmine Ng in Singapore at jng299@bloomberg.net. To contact the editors responsible for this story: Jason Rogers at jrogers73@bloomberg.net, Jake Lloyd-Smith