* Volatility attracts players from other commodity classes
* Citadel, Vermillion among the active funds- sources
* Competition among exchanges increases in iron ore
By Silvia Antonioli and Jacqueline Cowhig
LONDON, Oct 26 Growing liquidity in iron ore
derivatives is attracting hedge funds who have up until recently
ignored a market which is becoming a leading indicator of
underlying growth in China, the world's second largest economy.
A few pioneer funds have started to trade in this small but
fast-growing sector and many others are "watching it like a
hawk", waiting for further liquidity growth more before
entering, sources said.
"We want more exposure to iron ore to better express our
views on China," said a US-based manager of a fund, which has
recently started to trade iron ore swaps.
"We think iron ore is a better indicator of real demand. It
is more directly linked to China's underlying economy compared
with other commodities because it's still dominated by physical
A manager at a second U.S.-based firm which currently
focuses on base metals futures, said its fund is also active in
iron ore swaps, although this still represents less than 5
percent of its portfolio.
Volumes in the four-year-old cash-settled iron ore swaps
market have more than doubled every year so far to reach an
estimated level of about 100 million tonnes in 2012.
This is still small when compared with physical trade of
over 1 billion tonnes per year, second in physical volumes only
to oil, but the contract is now liquid enough for financial
players to take meaningful positions.
Among the funds currently trading iron ore swaps, market
sources mentioned energy-focused Vermillion and Citadel, and
Black River, a fund owned by agriculture commodity giant
Contacted by Reuters, Vermillion, Citadel and Black River
declined to comment.
At least 4 more funds are also said to be participating
"For sure there are more funds coming into the market,
that's one of the key growth areas right now," said Kerry Deal,
head of iron ore and bulk derivatives at brokerage Jefferies
Hong Kong Limited.
"It was just a question of when liquidity was going to grow
high enough to be suitable for hedge fund style of trading:
larger clips (deals), quickly. I think we are just starting to
see this now."
A fully developed derivatives market generally records
trading volumes between 5 and 10 times as big as the underlying
good but iron ore is a very large market so the growth seen so
far is extremely encouraging, market players said.
Adding to the appeal of iron ore derivatives
is the increasing volatility this product has registered.
The peaks and troughs seen in the last year have offered
better return potential than other more consolidated markets
such as copper which has been "dully" trading sideways most of
this year, traders said.
Iron ore swap volumes on the Singapore Exchange (SGX) hit
record levels of 17.7 million tonnes in September this year,
after a summer of violent price swings.
"Players generally involved in coal and freight are looking
to trade iron ore too, attracted by the higher volatility," FIS
broker Ian Thompson said.
SGX currently clears over 90 percent of the globally traded
iron ore swaps, with other clearers such as CME and LCH still
Lured by the expansion of this market, the new owners of the
London Metal Exchange, the biggest market place for base metals,
are also eager to launch a rival iron ore contract.
Stronger competition among exchanges can help move towards a
more sophisticated, screen-traded product, some argue.
"Iron ore swaps are all voice brokered (over the telephone)
and funds prefer the transparency and speed of getting in and
out of positions you get trading on screen," said a derivatives
trader at a European bank.
The entry of funds could also help reduce imbalances in the
iron ore swaps market.
While many large and small miners and traders have embraced
this market, some players still lament low levels of
participation of the natural buyers: the steelmakers.
Steel producers, especially the large ones, have often been
against iron ore and steel derivatives fearing that these might
take away their pricing negotiating power.
Brokers admit that there are still some problems with
liquidity on the buy side but swear the steelmakers' attitude
has greatly changed in the last few months.
"Now I see, all of a sudden, end users looking for means to
hedge, especially those who don't have their own mines," a third
broker said. "Until a year ago or so it was only chit-chat but
now it's actual business."