The futures spread is a good predictor of the present, a report highlighting that a spread of more than USD 20 per tonne between the 6 month forward iron price and the 24 month forward iron ore price is a robust SHORT signal for spot iron ore and iron ore equities whilst a spread of less than USD 6 per tonne is a robust LONG signal. The spread between the 6 month forward iron price and the 24 month forward iron ore price has reached USD 21.83 per tonne and whilst iron ore price momentum is still strong the spread suggests that spot iron ore prices are overbought at USD 138.70 per tonne.

Timing model suggests spot iron ore prices nearing a top. The spread between the 6 month and 24 month iron ore futures price has expanded to USD 21.83 per tonne as at 12 August. This is above the USD 20 per tonne level that precedes our SHORT spot iron ore signal, although our model requires momentum confirmation by a 3% fall in the spot iron ore price below its trailing one month high to actually trigger the SHORT signal.

The fact that our timing model could be triggered imminently indicates to us that near term sentiment which we believe is represented by the 6 month future is now well ahead of longer term fundamentals which we believe is represented by the 24 month future. Our timing model last issued a LONG spot iron ore signal on June 5th 2013 after the spread reached a low of USD 4.97 per tonne on May 29th 2013. Spot iron ore is up 26% from a low of USD 110.40 per tonne on May 31 to USD 138.70 per tonne.

But strong momentum means prices may rise further. The spot iron ore price may continue to rise in the near term despite the cautionary signal from the elevated futures spread. Iron ore exhibits strong price momentum trends as the physical market alternates between restocking and destocking cycles. Spot iron ore is currently trending strongly upwards with prices having risen USD 8.50 per tonne WoW to USD 138.70 per tonne as at August 12 due to we believe, restocking activity by Chinese steel mills.

Picking the precise inflection point when steel mills will step out of the market is challenging, which is why our timing model waits for a 3% spot price reversal before triggering a signal. We note that it has been 69 days since our LONG spot iron ore signal was triggered, above the historical minimum period between 10% spot iron ore price corrections of one month.

Read through for equities. Our analysis in the futures spread is a good predictor of the present concluded that when a LONG/SHORT signal is triggered by our timing model, it has tended to be followed by periods of outperformance and underperformance by iron ore equities. We have extended this analysis to short term trading opportunities and found there may be a short-term trading opportunity around SHORT signals.

A basket of global iron ore equities has typically run up prior to a SHORT signal, rising 11% on average from 40 weekdays to 10 weekdays prior to the signal, before falling 16% on average from 10 weekdays prior to the signal to 18 weekdays after the signal. The average fall from the signal point to bottom alone was 11%. LONG signals presented no such trading opportunity, implying that any out performance in equities from rising spot iron ore prices happens some time after the signal.