Feasibility Study of Iron Ore Futures Contract

Summer Internship Report 2009 – 2011 Feasibility Study of Iron Ore Futures Contract

Submitted By Vinay Madaan KHR2009PGDMF143

In partial fulfillment of Post Graduate Diploma in Management

Company Guide Mr. Dharmesh Pandya

Faculty Guide Prof. Rakhi Shrivastava

ITM Business School, Navi Mumbai, Kharghar

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Feasibility Study of Iron Ore Futures Contract

Acknowledgement
First of all, I wish to extend our heartfelt gratitude to Indian Commodity Exchange (ICEX) for giving the opportunity to perform Summer Project at their esteemed organization in Mumbai Corporate Office. I take this opportunity to convey my sincere thanks to the Company Guides, Mr. Dharmesh Pandya (National Business Head) and Ms. Harkiran Kaur for mentoring, guiding and supporting throughout the project. I sincerely owe a deep sense of gratitude to all the helpful people at ICEX Business Development Department and wish to put it on record that the present project had not taken its present shape without their support.

Finally I would like to thank ITM Business School and Prof. Rakhi Shrivastava, faculty guide for rendering her valuable time, knowledge and also for encouraging and appreciating my work. I would like to specifically mention that I have been highly benefitted by the experiences at ICEX as it helped me to imbibe managerial lessons.

Vinay Madaan KHR2009PGDMF143 ITM Business School, Navi Mumbai

ITM Business School, Navi Mumbai, Kharghar

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Feasibility Study of Iron Ore Futures Contract

Executive Summary

In this dynamic world where one is introduced with a new commodity almost every day, people think of understanding and managing the respective commodity with an intention of earning something out of them. With millions of commodities around, only some qualify to provide returns enormously. Some of them are like precious metals such as gold and silver. And another commodity which drives various economies around the world is iron ore. The project was envisioned in order to find the feasibility of iron ore as a futures contract to be traded in Indian commodity market. The study was based on interacting with real time traders by making them understand the benefits which ICEX provide such as transparency, swiftness and cost effectiveness. It involves visiting the gold commodity market and copper commodity market and converting them into a member of ICEX, thus also understanding the current trends being followed by these traders and in the markets. Along with this a secondary research was performed through internet and iron ore oriented books & journals to search for comprehensive data on iron ore to find its feasibility. Thus on the basis of above studies and market experience, this report suggested various measures and facts which proves the feasibility of iron ore futures contract in India commodity market. Besides this, it also elucidates the commodity profiles of gold and iron ore, with gold as a commodity being traded the most in the Indian commodity market.

Vinay Madaan KHR2009PGDMF143 ITM Business School, Navi Mumbai

ITM Business School, Navi Mumbai, Kharghar

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Feasibility Study of Iron Ore Futures Contract

DECLARATION

I, Vinay Madaan hereby declare that the Summer Internship project report entitled Feasibility Study of Iron Ore Futures Contract in India at Indian Commodity Exchange (ICEX) under the guidance of Mr. Dharmesh Pandya (company Guide), submitted to Professor Rakhi Shrivastava for the partial fulfillment to the award of degree of PGDM programme in ITM Business school, Kharghar, Navi Mumbai is my original empiricalresearch study, carried out from 11th May 2010 to 11th July 2010 and the same has not been submitted to any other institution / organization for the award of any other degree / diploma / fellowship of other similar titles or prizes or university by any other person. I further declare that all the facts and figures furnished in this project report are the outcome of my own intensive research and findings.

Place: Date:

Name_______________________

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Feasibility Study of Iron Ore Futures Contract

CERTIFICATE
(From Faculty Guide)

This is to certify that the project entitled “Feasibility Study of Iron Ore Futures Contract in India” submitted to Institute for Technology & Management, Kharghar, Navi Mumbai for the partial fulfillment of the degree of Post Graduate Diploma in Management, is a record of original work done by Vinay Madaan, during the period of his /her study and was under my guidance.

Signature:_____________________ Prof. Rakhi R. Shrivastava Faculty Guide Institute for Technology & Management Kharghar, Navi Mumbai.

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Feasibility Study of Iron Ore Futures Contract
Table of Content

1. Company profile ………………….……………........................................... 9
1.1 Introduction …………………………………………………………….. 9 1.2 Philosophy ………………………………………………………………. 9 1.3 About Founders ………………………………………………………… 10 1.4 Flagship in Other Services ……………………………………………… 10 1.4.1 Indiabulls Insurance ….……………………………………….. 10 1.4.2 Loans ………………….………………………………………. 11 1.4.3 Real Estate ……………..……………………………………… 11 1.4.4 Indiabulls Resources Ltd. ……..………………………………. 11 1.5 Indiabulls Market Share …………………..……………………………... 12 1.6 Indian Commodity Exchange (ICEX) ……………..……………………. 14

2. Commodity Profile – Gold ………………………………….……………. 18
2.1 Importance and Uses ………………………….…………………. 18 2.2 International Scenario ………………………….………………… 19 2.2.1 World Gold Supply ………………….…………………. 20 2.2.2 World Gold Demand …………………………………… 21 2.3 World Gold Markets ……………………………………………… 23 2.4 Domestic Scenario ………………………………………………... 23 2.4.1 Major Gold Mines in India ………...…………………… 24 2.4.2 Gold Demand in India …………..……………………… 24 2.4.3 Gold Imports in India …………..………………………. 25 2.5 Gold Prices …………………………….…………………………. 25 2.5.1 Factors Influencing Gold Prices ….…………………….. 27

3. Iron Ore - Introduction ………………...…………………………………... 28

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Feasibility Study of Iron Ore Futures Contract
3.1 Consumption & production of Iron Ore (Economic View) ……………… 30 3.2 Seaborne and Land-shipped Trade ………………………………………. 32 3.3 Steel Projections – Demand & Supply …………………………………… 34 3.4 Iron Ore Market and Its Pricing ……………………………….…………. 35 3.4.1 OTC Clearing Benefits …………………………….…………… 38 3.5 Growth Prospects: M&A Activity ………………………….……………. 38

4. Iron Ore – Product Guide ………..………………………………………... 42
4.1 Global Iron Ore and Steel Markets …………………….…………………. 42 4.2 Iron Ore Specifications and Types ………………….…………………….. 42 4.3 Price Relationships ……………………………….……………………….. 44 4.4 Iron Ore Market Status and Evolution ………….………………………… 45 4.5 Index Evolution and Platts Physical Methodologies ……….…………….. 46 4.6 Future Index and Benchmark Scenarios: The Oil Example .……………… 47 4.7 Iron Ore and Benchmarks ……………………………….………………… 47

5. Conclusion ………………………………………………………………………. 50 6. Bibliography …………………...……………………………………………….. 52

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Company Profile “Indiabulls – ICEX”

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Feasibility Study of Iron Ore Futures Contract
1. Company Profile
1.1 Introduction
Indiabulls Group is one of the top business houses in the country with business interests in Real Estate, Infrastructure, Financial Services and Power sectors. Indiabulls Group companies are listed in Indian and overseas financial markets. The Networth of the Group exceeds USD 3 billion. Indiabulls has been conferred the status of a “Business Superbrand” by The Brand Council, SuperbrandsIndia. Indiabulls Financial Services is an integrated financial services powerhouse providing Consumer Finance, Housing Finance, Commercial Loans, Life Insurance, Asset Management and Advisory services. Indiabulls Financial Services Ltd is amongst 68 companies constituting MSCI - Morgan Stanley India Index. Indiabulls Financial is also part of CLSA’s model portfolio of 30 Best Companies in Asia. Indiabulls Financial Services in partnership with MMTC Limited, the largest commodity trading company in India, has set up India’s 4th Multi-Commodities Exchange. Indiabulls Real Estate Limited is India’s third largest property company with development projects spread across residential projects, commercial offices, hotels, malls, and Special Economic Zones (SEZs) infrastructure development. Indiabulls Real Estate partnered with Farallon Capital Management LLC of USA to bring the first FDI into real estate. Indiabulls Real Estate is transforming 14 million sqft in 16 cities into premium quality, high-end commercial, residential and retail spaces. Indiabulls Real Estate has diversified significantly in the following business verticals within the real estate space: Real Estate Development, Project Advisory & Facilities Management: Residential, Commercial (Office and Malls) and SEZ Development. Power: Thermal and Hydro Power Generation. Indiabulls Securities Limited is India’s leading capital markets company with All-India Presence and an extensive client base. Indiabulls Securities possesses state of the art trading platform, best broking practices and is the pioneer in trading product innovations. Power Indiabulls, in-house trading platform, is one of the fastest and most efficient trading platforms in the country.. Indiabulls Securities Limited is the first brokerage house to be assigned the highest rating BQ – 1 by CRISIL.

1.2 Philosophy
Indiabulls has created a unique organization that is designed for you – the Smart Investor –. it passionately believe in the Smart Investor who wants to make his own educated investment choices and demands world class access to a full range of services and products ranging from Equities to Insurance, combined with the highest level of integrity, service and professionalism. Indiabulls is a full service investment firm offering clients access to a tremendous range of financial services from 135 locations across 95 cities. We have a strong team of over 1000 Client Relationship Managers focused on serving customers unique needs. Our world class
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Feasibility Study of Iron Ore Futures Contract
infrastructure, built with tens of crores of investment, provides our clients with real-time service, multi-channel & 24/7 access to all information and products. As we've expanded and developed to serve the needs of all kinds of investors, we've been guided by one underlying Philosophy: You come first. Indiabulls 1 2 FMS-IRM We are proud to introduce to you Indiabulls Professional NetworkTM that offers real-time prices, equity analysis, detailed data and news, intelligent analytics, and electronic trading capabilities, right at your finger-tips. This powerful technology is complemented by our knowledgeable and customer focused Relationship Managers who are available to help with your financial planning and investment needs.

1.3 About Founders
The fast paced growth, diversification and consolidation of the Group have been possible due to the vision and leadership of the cofounders of Indiabulls. Sameer Gehlaut is the Chairman, CEO and Whole Time Director of Indiabulls. Sameer is an engineer from IIT, Delhi (1995) and has worked internationally with Halliburton in its international services business in 1995. He has utilized his experience with the international best practices and professional work culture at Halliburton to lead Indiabulls successfully. Rajiv Rattan is the President, CFO and Whole Time Director of Indiabulls. Rajiv is an engineer from IIT, Delhi (1994) and has rich experience in the oil industry, having worked extensively across the globe in highly responsible assignments with Schlumberger. Rajiv has managed remote exploration projects providing evaluation services for different clients in India as well as abroad. Saurabh Mittal is a Director at Indiabulls. Declared the best graduating student in IIT, Delhi in (1995), Saurabh was also one of the engineers selected by Schlumberger to work for its international services business in 1995 and gained experience of working in various global locations. He graduated as a Baker Scholar with an MBA from the Harvard Business School. He has also developed in-depth understanding of international financial markets.

1.4 Flagship in Other Services
1.4.1 Indiabulls Insurance “When you hear the word Insurance, the words boring and mundane probably enter your mind.” When it comes to business, you are right up there. Taking all those split second decisions, avoiding pitfalls and making sure your money works hard for you. But don't you think the business of life requires just as much attention and probably even more. That's we are proud to bring to you an offer exclusively for you. As a part of our endeavor to provide you with world- class products and services, Indiabulls gives you the opportunity to avail of the whole

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Feasibility Study of Iron Ore Futures Contract
range of Birla Sunlife Insurance Products through the Indiabulls network of 1000 Relationship Managers over 135 locations nationwide. Which means you can take care of life, while taking care of business. As always, we put your needs first. 1.4.2 Loans • Personal Loan

“ No questions. Only Loans.” No matter where you work, or how much you earn, we offer you the shortest route to a loan with minimum paperwork and procedures. With Indiabulls Fast Loans, you can avail of easy loans for a minimum of Rs.10,000 to a maximum amount of Rs.1,00,000. Flexible loan tenure of up to 4 years (i.e. 1 month to 48 months). Loans available from a minimum of Rs.10, 000 up to a maximum of Rs.100,000. Easy monthly repayment through equated monthly installments (EMI). Easy documentation and quick disbursal • Home Loan

Indiabulls has commenced lending of Mortgage Loans to prospective customers under the flagship of Indiabulls Housing Finance Ltd. Here we enable home-seekers to access finance to buy, build, rent or improve their homes. We also provide plot loans, Loan against Residential, Commercial and Rental Property, thereby enabling the borrower to leverage the property owned to fund any legitimate needs be it Business Expansion, Child's Education, Child's Marriage or for holiday abroad. 1.4.3 Real Estate Through its group companies, Indiabulls is also engaged in real estate development. The group companies recently made winning bids for the Jupiter and Elphinstone Mills in Mumbai in an auction carried out by the National Textiles Corporation (NTC), a Government of India undertaking. The company will now develop modern commercial complexes in the heart of Mumbai - the financial capital of India. Indiabulls' foreign partner, Farallon Capital made the first real estate related FDI investment in Indiabulls Properties Pvt. Ltd to buy Jupiter Mills immediately after the new FDI guidelines were introduced by the Government of India for real estate development in March 2005. 1.4.4 Indiabulls Resources Ltd Indiabulls Resources Ltd, a 100 per cent subsidiary of Indiabulls Financial Services Ltd., has been established with the objective of evolving as an independent oil company over time. Our immediate short-term goal is to partner with oil companies who are willing to come to

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Feasibility Study of Iron Ore Futures Contract
India and bid in the current NELP-6 round. We are ready to invest along with such companies for exploration blocks of mutual interest. Indiabulls has grown its business by over 100% CAGR since inception. The growth of Indiabulls in a highly competitive market is a testimony of its quality services.

1.5 Indiabulls Market Share

ABULLS

SURESH RATHI

ICICI

INDIA INFO.

SHARE KHAN

KARVY

MOSt

CHARGES Demat A/C Trading A/C AMC BROKERAGE Delievery Trade Intra-day Trade

Rs.1000/ 1750(4+5) NIL

Rs.100 Rs.220 Rs.274

Rs.750 (4+5) Rs.500

NIL Rs.500 Rs.250

Rs.1000 Rs.1000 Rs.300

Rs.300/575 Rs.300 / 800/5000 NIL (4+5+6) NIL

50 paise

50 paise

F&O Trade

05 05 paise paise(min1 p) 05 paise 05 paise

0.4-0.85% 0.250.50% 0.20.070.425% 0.10% 10.10.15% 0.060.10%

50 paise 06 paise

30 paise 03 paise

Rs.35paise Rs.05 paise

08 paise

03 paise

Rs.05 paise

EXPOSURE Delievery Trade Intra-day Trade F&O Trade

2/4 times 12 times 75% of cash NA

NIL 10 times NA

NA 10 times NA

2 times 8 times NA

NIL NIL NIL

NIL 5 times(14+ unlimited 15+16) NIL

INITIAL AMT.

NA

Rs.5200

2500/5000 Rs.300/500 NA 0 Rs.3/pc Rs.30/pc

NA

DEMATERILISATION REMATERILISATION

Rs.7/pc NA

NA NA

Rs.35+2/pc Rs.25+5/pc Rs.5/pc Rs.20/pc RS.25+15/ Rs.35/pc pc YES(3000/ YES 7999)

Rs.25/pc Rs.35/pc

SOFTWARE

YES(PIB)

NO

interest

NO

YES

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Feasibility Study of Iron Ore Futures Contract
Fig. 1: Market Share of Indiabulls Competitors

SHARE KHAN

7% 17% 13% 13% 30% 20%
INDIA INFOLINE ICICI DIRECT

SURESH RATHI

INDIABULLS

OTHERS

The commodities futures market in India is only about 3 times the size of physical market, whereas it is more than 10 times the size of physical market in other developed countries. Therefore, the current state of commodities market in India leaves lot of scope for growth in terms of depth and reach of the market as well as attracting new players who are utilizing the services of overseas commodities market due to various reasons like lack of depth in product category they wish to trade in; inadequate warehousing facilities at strategic locations, etc.

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1.6 Indian Commodity Exchange Limited (ICEX)
ICEX is a screen based on-line derivatives exchange for commodities and has established a reliable, time tested, and a transparent trading platform. It is also in the process of putting in place robust assaying and warehousing facilities in order to facilitate deliveries. It is jointly promoted by Indiabulls Financial Services Ltd and MMTC Limited, and will have Indian Potash Ltd among others, as partners. This exchange is ideally positioned to tap the huge scope for increasing the depth and size of commodities' market and fill in the structural gaps existing in the Indian market. Our head office is located in North India (Gurgaon), one of the key regions in India's Agri belt, with a vision to encourage participation of farmers, traders and actual users to hedge their positions against the wild price fluctuations. Corporate Vision • • • Provide fair, transparent and efficient trading platform to all participants Meet the international benchmarks for the Indian commodity market Provide equal opportunity and access to investors all over the country through the modern communication modes Attract a wide array of end users, financial intermediaries and hedgers

• • •

Become a major trading hub for most of the commodities To provide product portfolio to suit the trading community needs in an efficient manner We will provide the widest range of benchmark future products available on any exchange, covering all major commodities. Our collective vision is global growth, innovative product development, continually enhanced echnology and the highest level of service available on any exchange. We offer future trading in Agricultural commodities, bullions, base metals, and energy. Our objective is to serve customers with a global product line, virtually round-the-clock electronic trading and strategic alliances with other leading players. We also offer a number of programs and products designed specifically to appeal to a global audience.

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Key differentiators • • • • • Joint venture between Public/Private entities Well capitalized Rs. 100 Cr initial capital Reputation of partners and pan India presence Key stake holders having rich experience in the domain viz. commodities, warehousing, financial markets Professionally driven exchange with an entrepreneurial mindset Aim to remove discrepancy in the commodities market by building transparency in the exchange Unprecedented price transparency and market depth

MMTC Ltd, a Government of India enterprise, is the largest international trading company of India having annual turnover of more then US$ 7Billion or Rs. 36000 Crore. It is among the leading international trading company of South Asia having experience of more then 45 years in bulk trading of diverse commodities and products. It is present in 56 locations in India through offices, warehouses, port offices & retail outlets. It is the largest exporter of Minerals and single largest importer / supplier or Bullion & Non-Ferrous Metals in India. MMTC is also leading in trading of Agro products, Fertilizers, Coal & Hydrocarbons, textiles, chemicals etc. MMTC Ltd has a fully owned subsidiary, MTPL in Singapore and also a promoter of NINL in Orissa, an Iron & Steel plant MMTC Limited, India’s first Super Star Trading House, continues to be the country's leader in mineral exports for four decades now. During the last decade, MMTC could withstand the stiff competition in the world market by its continuous and persistent efforts in diversifying its markets, enlarging its product range, expanding extensively its infrastructure facilities and expertise in mineral operations, and by attaching utmost care and importance to its trade commitments as also the quality of service and products. MMTC has been consistently striving to enhance its competitiveness in the area of value addition. It has set up a crushing and screening plant at Banehatti in Bellary Hospet Sector not only to source higher value realization in the international market but also to compete with the international suppliers like Australia and Brazil in the markets like Japan and South Korea. MMTC has provided further fillip to value addition to minerals. The 1.1 million ton Steel Plant consumes about 2 million tons of various types of minerals annually being supplied by MMTC. The company has also taken an initiative to link import of capital equipments required for modernizing mining activities in the country to promote export of minerals. The import of the earthmoving equipments was linked to export of Iron Ore under EPCG scheme.

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Feasibility Study of Iron Ore Futures Contract
Items of Trade • • • • IRON ORE MANGANESE ORE CHROME ORE OTHERS (Mud Chemicals, Barytes, Bentonite, Bauxite, Talc, Gypsum, Feldspar, Quartz/Silica Sand, Garnet Sand, Kaolin (China Clay), Vermiculite)

Destination of Exports MMTC exports Iron ore to Japan, South Korea, China, Middle East etc. The export is both on the basis of long term and annual spot contracts.

Leader in Mineral Exports MMTC's performance in mineral trade has been acknowledged by the CAPEXIL (Chemicals and Allied Products Export Promotion Council) by conferring the nation's highest award for excellence in mineral exports 13th time in succession.

Mode of Sales MMTC's mineral sales are on FOB basis only.

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Commodity Profile “Gold”

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Feasibility Study of Iron Ore Futures Contract
2. Commodity Profile - Gold
Gold is primarily a monetary asset and partly a commodity. Gold is the world's oldest international currency. It is an important element of global monetary reserves. Central banks, and official international institutions, have been major holders of gold for more than 100 years and are expected to retain large stocks in future. Gold has maintained its purchasing power throughout its 5,000-year track record, as the world’s only monetary metal. It is considered as a commodity as it can be acquired and stored in the form of Jewellery, Bars, Coins and Gold Deposits. It is also called precious metal, which means it does not rust (oxidise) at normal conditions. It is resistant against many acids and a good electric conductor, which makes it useful for electronic circuits. It is useful for jewellry because of its inertness.

2.1 Importance and Uses
Gold has mainly three types of uses: Jewellery Demand, Investment Demand and Industrial uses. • Jewellery Demand - Jewellery consistently accounts for around three-quarters of gold demand. In terms of retail value, the USA is the largest market for gold jewellery, whereas India is the largest consumer in volume terms, accounting for 25% of demand in 2007. Investment demand - Investment demand in gold has increased considerably in recent years. Since 2003, investment has representing the strongest source of growth in demand, with an increase in value terms to the end of 2007 of around 280%. Industrial Demand - Industrial and dental uses account for around 13% of gold demand (an annual average of over 425 tonnes from 2003 to 2007 inclusive).The value of gold is a result of its rareness and also of its interesting physical characteristics. Pure gold is too soft for ordinary use and is typically hardened by alloying with copper or other base metals. The gold content of gold alloys is measured in carats (k), pure gold being designated as 24k.

Gold market is highly liquid and gold held by Central Banks, other major institutions and retail jewellers keep coming back to the market. Due to large stocks of gold as against its demand, it is argued that the core driver of the real price of gold is stock equilibrium rather than flow equilibrium. It is effective portfolio diversifier, which summarizes the usefulness of gold in terms of modern portfolio management. Gold is effective diversifier during economic stress periods or instability. Over 60 countries including South Africa, US, Australia and Russia

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Feasibility Study of Iron Ore Futures Contract
mine gold. Although gold mining industry is enjoying higher prices in recent years, they suffer because of higher input costs. Global mining output is also declining as quality and easily accessible ore has been mined at most of producing countries.

2.2 International Scenario
South Africa, the United States and Australia are the three largest gold producing countries. Other major producers are Canada, China, Indonesia, and Russia. But if we measure only the current year’s production, China has become the world’s largest producer of gold, overtaking South Africa’s top position in 2007. As gold has been considered as a proxy currency, its reserves are held by Governments i.e., Central Banks/ institutions of various countries. The survey carried out in 2005 revealed that US, Germany, France, Italy, Switzerland, Netherlands, Japan, Portugal, Spain and China were the countries where official gold holdings stood over 500 tons. World Gold Demand & Supply

Source: GFMS Global demand ruling higher compared with supply (including mine output and old gold scrap) in recent years and as a result the market has witnessed price escalation. According to World Gold Council, gold mine production has declined to 2407 tons in 2008 compared with 2486 and 2473 tons in 2006 and 2007 respectively. The total gold supply including old gold scrap has been declining and stood at 3468 tonnes in 2008 as compared to previous year’s gold supply of 3488 tonnes.

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2.2.1 World Gold Supply • Mine production

Gold is produced from mines on every continent except Antarctica, where mining is forbidden. According to data of year 2007, there are around 400 operating gold mines worldwide. Depending on the geologic situation, the mining is very different. However, the overall level of global mine production is relatively stable, averaging approximately 2,525 tonnes per year over the last five years. The most important gold producer of the world is South Africa. The mines in South Africa can provide several superlatives. The Kruger Rand gold coins are world famous. The East Rand Mine is the world's deepest mine, 3585 m below surface. The Free Gold Mine was the world's most productive gold mine with the output of 115 tons per year. Driefontein Consolidated Mine has produced more gold than any other gold mine, about 2292 tons. Deepest single-drop mining shaft in the world has been sunk at South Deep Gold Mine. • Scrap

However, although gold mine production is relatively inelastic, recycled gold (or scrap) ensures there is easily traded supply when needed, and this helps to stabilise the gold price. Between 2003 and 2007, recycled gold contributed an average 26% to annual supply flows. • Central Banks

Central banks and supranational organisations (such as the International Monetary Fund) currently hold gold as reserve assets amounting to around 29,000 tonnes, dispersed across 110 organisations. On average, governments hold around 10% of their official reserves as gold. However, the proportion varies country-by-country. Although a number of central banks have increased their gold reserves in the past decade, the sector as a whole has been a net seller since 1989, contributing an average of 520 tonnes to annual supply flows in 2003-2007. Net central bank sales amounted to just 486 tonnes in 2007 and it decreased to 279 tonnes in 2008.

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Feasibility Study of Iron Ore Futures Contract

Major Gold Producing Countries Fig. 2: Major Gold Producing Countries’ Share

China, United States, South Africa and Australia were the major producers of gold in 2008. These countries contributed over 40% of the total global mine production.

2.2.2 World Gold Demand Demand for gold is widely spread around the world. East Asia, the Indian sub-continent and the Middle East accounted for 72% of world demand in 2007. 55% of demand is attributable to just five countries - India, Italy, Turkey, USA and China. Gold demand mainly comes from Jewellery consumption, Industrial and investment uses. • Jewellery Demand

Jewellery consistently accounts for around three-quarters of gold demand. In the 12 months to December 2007, this amounted to US$54 billion, making jewellery one of the world's largest categories of consumer goods. In terms of retail value, the USA is the largest market for gold jewellery, whereas India is the largest consumer in volume terms, accounting for 25% of demand in 2007.

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Feasibility Study of Iron Ore Futures Contract

Investment Demand

Investment demand in gold has increased considerably in recent years. Since 2003, investment has representing the strongest source of growth in demand, with an increase in value terms to the end of 2007 of around 280%. Investment attracted net inflows of approximately $15bn in 2007. • Industrial Demand

Industrial and dental uses account for around 13% of gold demand (an annual average of over 425 tonnes from 2003 to 2007 inclusive). Identifiable Gold Demand (in tonnes)

Source: www.gold.org East Asia, the Indian sub-continent and the Middle East accounted for 72% of world demand in 2007. 55% of demand is attributable to just five countries - India, Italy, Turkey, USA and China. India is the world’s largest gold consumer, followed by China. Demand for gold, including jewellery, industrial, and investment demand has broadened in recent years. In China, which has overtaken the US as the second largest retail market, jewellery demand ruled strong in 2007. In 2007, the total demand has overtaken the total supply.

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Feasibility Study of Iron Ore Futures Contract

2.3 World Gold Markets
London: London Bullion Market Association (LBMA). It is world’s biggest market major clearinghouse of gold. New York: New York Mercantile Exchange Commex Division (NYMEX) begins trading on 31st December 1974. It is mainly considered as “home of futures trading” Zurich: It is also one of the major spot and future market in Europe mainly known as a “Physical Turntable”. Istanbul: Istanbul Gold Exchange begins trading on 26th July 1995. Major gold spot and futures market are in Turkey and Middle East. Dubai: Dubai Gold & Commodities Exchange (DGCX) begins trading in June 2005, Major spot gold market for Saudi and gulf countries. It is also one of the famous jewellers market. Singapore: It is doorway to South East Asian consuming countries major spot and future market. Hong Kong: It is doorway to China, now one of the major gold consuming countries in the world. Tokyo: Tokyo Commodities Exchange (TOCOM) begins trading on 23rd March 1982, major spot and future market in Japan. Shanghai: began trading on 26 July 1995. It is one of the major future centers in the China. Turkey has become an important net exporter. Vietnam, usually a large buyer; and Thailand are also exporting gold now. • Units of weight

Around the world, bars can be denominated or traded in different units of weight to accommodate the preferences of regions or countries. The most prominent units are the gram (international), troy ounce (US, UK and Australia), tola (Indian subcontinent and Middle East), tael (Hon Kong and Taiwan), baht (Thailand) and chi (Viet Nam).

2.4 Domestic Scenario
India is arguably the largest bullion market in the world. It has been until now, the undisputed single-largest Gold bullion consumer, with its own final demand outweighing the next largest market – China by almost 57 percent. But it seems now, that the Chinese Gold buyers have caught up during 2008 as Chinese demand is surging rapidly (up by 15 percent year-on-year). Indian demand fell as Indian Gold sales collapsed by about 65 percent in the year 2008. In spite of being the largest consumer of gold, India plays no

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major role globally in influencing this precious metal's pricing, output or quality issues. India’s total gold holdings are between 10,000 tonnes and 15,000 tonnes of which the Reserve Bank of India has only around 400 tonnes. India has the largest number of gold Jewellery shops in the world. 2.4.1 Major Gold Mines in India There is a huge mismatch between demand and primary supply in India, the balance being made up by imports. The only major gold mine currently in production is the Hutti mine, owned by Hutti Gold Mines Company Limited, which produces around 3 tons of gold a year. Hindustan Copper also produces some gold as a by-product. Gold Production in India

Production in recent years (in tons) Source: www.pib.nic.in *p - provisional As given in the above table, gold production in India is ruling lower in recent years. Karnataka was the leading producer of this precious metal with the output ranging from 2 to 3 tons per annum during 2005-06 and 2007-08. Jharkhand also produces small quantity of gold. 2.4.2 Gold Demand in India Gold, the ultimate safe haven in troubled times, remained the hot commodity throughout the year. It scaled new heights in the global markets and in India, which is the largest buyer of the metal.

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Gold Demand in India vs World (Tonnes)

Source: GFMS * provisional Indian demand for Gold accounts for on an avg. 25% share of world gold demand. In 2008, demand for gold has decreased in India because of high price amid global financial crisis. 2.4.3 Gold Imports in India India imports around 500-800 tonnes of gold on an average every year. In 2008, India’s gold imports dipped by 45 per cent to touch 450 tons. However, buying of gold Jewellery has fallen sharply in January, February & March month of the year 2009, leading to a slump in the yellow metal’s imports.

2.5 Gold Prices
There are many factors, which affect the gold prices in domestic as well as international market. However, it is highly correlated with the US dollar, the world's main trading currency. Gold has long been regarded by investors as a good protection against depreciation in a currency's value, both internally (i.e. against inflation) and externally (against other currencies). Gold is widely considered to be a particularly effective hedge against fluctuations in the US dollar, the world's main trading currency.

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Fig. 3: Gold Price vs Dollar Movement

The gold price has been found to be negatively correlated with the US dollar and this relationship appeared to be consistent over time. It is a consistently good protection against the economic instability and the exchange rate fluctuations. Fig. 4: Gold Prices in Domestic & International Market

Note: Average price from Jan to Aug for 2009

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Gold prices are skyrocketing over the years both in the national and international markets. However, the price increase in the national market was significant during the current year as average price (till end of Aug ’09) ruled at about Rs.14,600 per 10 grams compared with the annual average of Rs.12,670 per 10 grams in 2008. With this, the market has witnessed price appreciation of about 15% compared with merely 5% international market for the same period, which could be mainly linked to the currency factor. 2.5.1 Factors influencing Gold Prices World macro economic factors including US Dollar, interest rate and so on, Global gold mine production, Demand by Central banks, Domestic demand, which is linked to agricultural prosperity and festivals/marriages etc, Producer / miner hedging interest, Comparative returns on stock markets, US dollar movement against other currencies, Indian rupee movement against the US dollar, Geopolitical tensions, Global economic situation.

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Project “Feasibility Study of Iron Ore Futures Contract in India”

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3. Iron Ore - Introduction
Iron ore, mainly hematite (Fe2O3) as a primary source of iron, is a raw material used to make Pig Iron, which is one of the main raw materials to make steel. 98% of the mined iron ore is used to make steel. Indeed, it has been argued that iron ore is “more integral to the global economy than any other commodity, except perhaps oil”. However, in some situations, more inferior iron ore sources have been used by industrialized societies when access to high-grade hematite ore was not available. There are four main types of iron ore deposits worked currently, depending on the mineralogy and geology of the ore deposits. These are magnetite, titan magnetite, massive hematite and pisolitic ironstone deposits. Branded iron deposits or branded iron formations are metamorphosed sedimentary rocks composed predominantly of thinly bedded iron minerals and silica (as quartz). The typical grade of iron at which a magnetite-bearing banded iron formation becomes economic is roughly 25% Fe, which can generally yield a 33% to 40% recovery of magnetite by weight, to produce a concentrate grading in excess of 64% Fe by weight. Currently magnetite iron ore is mined in Minnesota and Michigan in the U.S., and Eastern Canada mine taconite. Magnetite bearing BIF is currently mined extensively in Brazil, which exports significant quantities to Asia, and there is a nascent and large magnetite iron ore industry in Australia. Another, minor, source of iron ores are magmatic accumulations in layered intrusions which contain a typically titanium-bearing magnetite often with vanadium. These ores form a niche market, with specialty smelters used to recover the iron, titanium and vanadium. These ores are beneficiated essentially similar to banded iron formation ores, but usually are more easily upgraded via crushing and screening. Hematite iron ore deposits are currently exploited on all continents, with the largest intensity in South America, Australia and Asia. Hematite iron is typically rarer than magnetite bearing BIF or other rocks which form its main source, but it is considerably cheaper to process as it generally does not require beneficiation due to its higher iron content. Export grade Hematite ores are generally in the 62–64% Fe range.

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3.1 Consumption & production of Iron Ore (Economic View)
Iron is the world's most commonly used metal - steel, of which iron ore is the key ingredient, represents almost 95% of all metal used per year. It is used primarily in structural engineering applications and in maritime purposes, automobiles, and general industrial applications (machinery). Iron-rich rocks are common worldwide, but ore-grade commercial mining operations are dominated by the countries listed in the table below –
Mine Production 2,008 2,009
China Brazil Australia India Russia Ukraine United States South Africa Other countries Iran Canada Sweden Kazakhstan Venezuela Mexico Mauritania World Total (rounded) 824 355 342 220 100 73 54 49 47 32 31 24 23 21 12 11 2,220 900 380 370 260 85 56 26 53 47 33 27 18 21 16 12 11 2,300

Reserves Crude ore Iron content
22,000 16,000 20,000 7,000 25,000 30,000 6,900 1,000 11,000 2,500 1,700 3,500 8,300 4,000 700 700 1,60,000 7,200 8,900 13,000 4,500 14,000 9,000 2,100 650 6,200 1,400 1,100 2,200 3,300 2,400 400 400 77,000

*Estimated iron ore production in million metric tons for 2008 & 2009 according to U.S. Geological Survey The major constraint to economics for iron ore deposits is not necessarily the grade or size of the deposits; because it is not particularly hard to geologically prove enough tonnage of the rocks exist. The main constraint is the position of the iron ore relative to market, the cost of rail infrastructure to get it to market and the energy cost required to do so. Mining iron ore is a high volume low margin business, as the value of iron is significantly lower than base metals. It is highly capital intensive, and requires significant investment in infrastructure such as rail in order to transport the ore from the mine to a freight ship. For these reasons, iron ore production is concentrated in the hands a few major players. According to the table above, the 2008 & 2009 world average production level of raw iron amounts to 2.2 billion metric tons and 2.3 billion metric tons, respectively. It is expected that in the next few years, import volume of major iron ore importers will rise, and the total import volume will show a slight upward trend with an increase of over 5%. However, China’s import growth will be stable, not very possible to break 500 million

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tons. Australia and Brazil dominate the seaborne trade, with 72% of the market. BHP, Rio and Vale control 66% of this market between them. The total recoverable reserves of iron ore in India are about 9,602 million tones of hematite and 3,408 million tones of magnetite. Madhya Pradesh, Karnataka, Bihar, Orissa, Goa, Maharashtra, Andhra Pradesh, Kerala, Rajasthan and Tamil Nadu are the principal Indian producers of iron ore.

Controlling entity
Cia Vale Do Rio Doce Rio Tinto plc BHP Billiton Ltd State of India Arcelor Mittal Metalloinvest Anglo American Cliffs Natural Resources System Capital Management LKAB (State of Sweden) Total 10 largest Total world

Country
Brazil UK Australia India UK Russia South Africa USA Ukraine Sweden

Controlled Share of total production (Mt) world production (%)
303 150 137 54 (estimated) 46 (estimated) 38 (estimated) 36.7 32.7 24.5 23.9 846 1746 17.3 8.6 7.8 3.1 2.6 2.2 2.1 1.9 1.4 1.4 48.4 100

Notes: State of India includes SAIL and NMDC. Source: Raw Materials Data, Stockholm 2009 World consumption of iron ore grows 10% per annum on average with the main consumers being China, Japan, Korea, the United States and the European Union. China is currently the largest consumer of iron ore, which translates to be the world's largest steel producing country. It is also the largest importer, buying 52% of the seaborne trade in iron ore in 2004. China is followed by Japan and Korea, which consume a significant amount of raw iron ore and metallurgical coal. In 2006, China produced 588 million tons of iron ore, with an annual growth of 38%. It is hard to assume the recovery time of iron ore demand in 2009, which to a large extent lies on the consumption rate of Chinese port stock as well as China’s domestic iron mining and utilization. It is also believed that another major factor should not be ignored is global crude steel productivity and it is estimated that the global crude steel production growth rate will

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decline. Iron ore reserves at present seem quite vast, but some are starting to suggest that the maths of continual exponential increase in consumption can even make this resource seem quite finite. For instance, Lester Brown of the Worldwatch Institute has suggested iron ore could run out within 64 years based on an extremely conservative extrapolation of 2% growth per year.

3.2 Seaborne and Land-shipped Trade
International iron ore trade reached record levels at 512 million tonnes (Mt) in 2002. Iron ore miners around the world see a silver lining after some difficult years. Price negotiations in 2003 were, if possible, even tougher and more protracted than in 2002 – but they resulted in a 9 per cent price increase on average. The unbelievably strong developments in the Chinese steel industry have set the pace globally. Steel production in China was 182 Mt in 2002, a double digit increase for the second consecutive year. In the first 5 months of 2003 the growth rate is as high. Total global crude steel production in 2002 was 902 Mt – a 6.2 % increase over 2001 indicating a healthy trend also in other parts of the world. But there are also some dark clouds on the rosy morning sky. Medium and small iron ore producers, particularly those who have been hit by the weakening US dollar are facing difficult years. The iron ore industry has been consolidating rapidly in recent years. A triumvirate has developed consisting of Brazilian Companhia Vale do Rio Doce (CVRD) and British/ Australian giants, BHP Billiton and Rio Tinto. Together these three companies control over 30 % of world production and, more importantly, over 70 % of world seaborne trade. There is a danger that the producers behind the top troika will become marginalised price takers, without much influence on future developments. The danger that the strong oligopolistic structure of the iron ore sector will influence prices should not be neglected either. To measure corporate control at the mine stage underestimates the concentration of iron ore producers since many mines are captive with a protected market. The share of seaborne trade is an alternative method of assessing market power. CVRD alone controls over 34 % of the total world market for seaborne iron ore and the three largest companies control 70 %. This illustrates more clearly the potential influence over prices by the major producers. Falling steel demand is butting up against iron ore production capacity growth and current under-utilization. Also, in terms of seaborne trade volume, despite the potential for smaller high-cost-basis mines in China to shutdown (increasing the need for imported ore), seaborne iron ore trade is indeed expected to decline along with lower global, and particularly Chinese, steel demand. Clarkson sees seaborne trade volumes falling

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back to 2007 levels, as shown below.

Fig. 5: Seaborne Trade in Iron Ore, 2000-2009, Mt, (projected 2009)

Source: Clarkson, Dry Bulk Trade Outlook, May 2009 For iron ore in general (seaborne or land-shipped), one particular UNCTAD chart really captured the problem ore pricing faces over the next few years, shown below. Essentially, new ore production capacity additions will outstrip new demand by a wide margin. While the demand estimate they use might be a bit too conservative, particularly if Chinese demand rebounds well say in late 2010, the supply/demand gap is large enough to accommodate even a pretty substantial upside surprise in terms of steel demand for 2009 2011. Nevertheless, one feasible way to close this gap would be if a sizeable amount of Chinese ore production shut down due to high costs, and do so very rapidly, faster than UNCTAD has put in their numbers.

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Fig. 6: Supply – Demand Balance 2009-2011(Mt/y)

3.3 Steel Projections – Demand & Supply
UNCTAD recently released report forecasting a 15% decline in global steel demand, which comes after a 1.4% decline in 2008. While most of the world is expected to experience sharp declines in demand, even China is expected to see a 5% decline, though in 1Q09 China still eked out 0.8% of demand growth.

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Fig. 7: World Crude Steel Production

Source: World Steel Association The global contraction in demand has resulted in extremely low May 2009 capacity utilization levels of 43%, 49%, and 55% for the steel industries in the US, Europe, and Japan. Again, even China, despite its growth, was recently about 78% utilization as per the UNCTAD piece, and via other sources is expected to see capacity utilization in the 70% range this year due to over expansion of steel capacity. The UNCTAD report implies that most of the 5% decline in Chinese demand should be weighted towards the second half of 2009. The worst is yet to come from China in terms of steel demand, and keep in mind UNCTAD takes note of Chinese government stimulus plans.

3.4 Iron Ore Market and its Pricing
Over the last 40 years, iron ore prices have been set by a so-called benchmark system, between miners and steelmakers. Traditionally, the first deal reached between these two groups set a benchmark to be followed by the rest of the industry. Thus, a single price would be negotiated once per year. A spot market also exists however it has traditionally been much smaller. The problem with this system is that when spot prices are higher than

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the benchmark, miners lose the extra revenue which would have been earned by selling ore on the spot market. When spot prices are lower than the benchmark, some steel mills cheat, purchasing their ore from the spot market. In other words, the benchmark system provides protection for the steel mills, but not the miners. On the other hand, the benchmark system offers price stability to miners and steel mills, allowing them to plan their production more effectively. In recent years, the benchmark system has begun to break down, with some miners pushing for their customers to use the spot market, and negotiations with the largest buyer, China, causing friction. As the spot market has grown in size and importance, financial hedging instruments such as iron ore swaps have emerged. Given that most other bulk commodities (such as coal) have evolved to a market based pricing system, it is a fair bet that iron ore will also follow this path in the medium to long term. However, in some cases, the cost of shipping is greater than the value of the ore. This is of particular relevance to Brazilian iron ore, which needs to travel much further to reach China than Australian iron ore. For this reason, Australian producers have in the past argued for a premium on their ore, due to the fact that it is vastly cheaper to ship. A new global growth pattern produced a major change in the dynamics of the iron ore market. The new iron ore pricing system which involves a decision to move existing iron ore contracts to index-based prices, smoothes the natural daily spot price volatility as it establishes a quarterly iron ore price based on a three-month average of price indices for the period ending one month before the onset of the new quarter. While retaining flexibility, the system allows steel companies to be known beforehand the price to be paid in the following quarter, thus facilitating cost control and inventory management. Consistent with the requirements of a modern economy, the price system minimizes the cost of price discovery, eliminating one important source of inefficiency. The new pricing system has several major advantages over the annual price negotiations. It produces significant efficiency gains, saving costs and providing the right stimulus to investment, brings flexibility with cost predictability, and enhances transparency. It will be mutually beneficial to steel and mining companies, boosting their contribution to global economic and social prosperity. For over 40 years, representatives of the world’s largest mining companies have held “closed door” talks to establish an annual “benchmark price” for delivery contracts with the big steel producers. During the past year this pricing system has been challenged. China, the world’s largest importer of Iron Ore, did not accept the benchmark prices agreed between the producers and Japan in 2009, choosing instead to purchase ore in the open spot market.

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Close to 60% of all iron ore is now transacted in the spot market. The threat to the traditional pricing system has greatly boosted the importance of the spot market and hybrid contracts. Iron ore swaps are becoming a more usual feature of the price picture.

Key issues for growth are: • • • Education Confidence in Index pricing Access to cash collateral

A move away from the annual benchmark prices will lead to more volatile prices for steel and other goods that require such steel. This impacts ship building, car manufactures and household goods suppliers. We expect to see a substantial impact on the bottom line of miners and steel mills alike Risk management tools are becoming more in demand and educational programs sprout Since the Mid 1990s China has emerged as the main player in the iron ore market, replacing the traditional key importers such as Japan and South Korea. China now buys over 70% of all seaborne iron ore - more than 700 million MT per year. Iron Ore is of key importance to the shipping industry – often pushing down FOB prices even as CIF prices are rising. Use of iron ore swaps growing steadily. First Asian dominated OTC commodity market.

Fig. 8: Relationship Between Iron Ore Swaps and Steel Swaps

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3.4.1 OTC Clearing Benefits • • • • • • • • • • • • Reduced counterparty credit risk. Risk borne by clearing member and clearing house. Increased trading opportunities. Eliminating need to evaluate credit risk of each potential counterparty gives participants greater access to more prices. More efficient use of capital. Frees up bilateral credit lines for non-cleared trades. Maintains anonymity. Unlike bilateral trades, original counterparties remain anonymous from trade to delivery. Multilateral netting. Capital efficiency across multi-market (OTC/futures) positions through cross margining. Streamlined front and back office operations. Available straight through processing and post trade management ensures trades are automatically confirmed and routed to back office departments and risk management systems. Increased market transparency. Daily mark to market.

• •

3.5 Growth Prospects: M&A Activity
As the global economy begins to recover, deal making might offer the leverage metals companies need to push ahead of the competition. It will be the companies with strong balance sheets and robust cash reserves that are in the best position for strategic merger and acquisition opportunities. In the context of a recovering economy, increasing demand and a more productive steel industry, merger and acquisition (M&A) activity is a given. The Central Asia/Asia-Pacific region remains a major focus for deal activity, with China now the leading acquirer. China’s leadership recognizes that the domestic metals industry is still characterized by the prevalence of old, inefficient companies run by individual, provincial governments. The national government is, therefore, encouraging consolidation of these companies as a way to both increase efficiency and help meet China’s huge demand for steel products. In 2009, China imported 627.8 million tons of iron ore, raising the country’s reliance on imported ore to 63.9 percent of its needs. To help alleviate that dependency, Chinese companies are looking overseas for acquisitions that will ensure a more reliable supply of raw materials. As an example, Chinese industry leaders such as Wuhan Iron & Steel and Shanghai

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Baosteel Group have acquired or made significant investments in Australian companies producing iron and coal. In Brazil, the East China Mineral Exploration and Development Bureau has agreed to buy the Itaminas iron ore mine from its owner, Bernardo de Mello. To make the right deal, metals companies must consider how two years of economic contraction have altered the balance of supply and demand within the value chain, as well as how it has significantly changed and elevated the importance of due diligence. Healthcare, climate change, commodity prices, pension plan structures, changing tax laws, company culture and the role of human resources must be factored into today's due diligence process. Fig. 9: Global M&A Activity by Geographical Region

Source: Thomson SDC Two mega deals fueled by a quest for iron ore by Chinese companies-were announced during the first quarter of this year. Both of these deals involve iron ore, as well as Chinese acquirers. The largest deal announced in the first quarter was Chinalco’s $1.35 billion minority stake transaction in Rio Tinto’s Simandou (Guinea) iron ore joint venture. The second mega deal announced in the first quarter is the $1.22 billion East China Mineral Exploration & Development Bureau acquisition of Brazilian iron ore miner Itaminas Comercio de Minerios, which is estimated to have 1.3 billion metric tons of iron ore reserves. Signs of recovery appeared in the metals sector during the first quarter of this year as 21 deals were announced with a total combined value of $5.9 billion.

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Globally the relative sense of urgency to engage in new deals is likely greatest for steel companies, which face a consolidated basis of iron ore suppliers. This could lead to additional horizontal mergers among steel constituents or backward integration. Looking forward in 2010, the sector’s M&A flow will likely continue to grow. Source: PwC Report

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Iron Ore – Product Guide

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4. Iron Ore – Product Guide
Fig. 10: Platts Iron Ore and Dated Brent Crude Price Assessments

4.1 Global Iron Ore and Steel Markets
Iron ore is the primary raw material used in the production of steel and — combined with steel — constitutes the world’s second largest commodity bloc by value, after crude oil. At least 800 million tonnes of iron ore are produced annually, whilst production of finished steel probably accounts for about 1.1 billion tonnes of production a year, emphasizing the scale of these closely-linked markets.

4.2 Iron Ore Specifications and Types
Iron ore is categorized by dint of where it is produced and priced, and by its ferrous content, expressed as a percentage. The largest producing countries are Australia, Brazil, India, South Africa and China. Major consuming countries include China — with approximately 60% of global steel production in 2009/10 — Japan and Korea, as well as most developed and developing countries. The 62% ferrous content grade has attracted liquidity in swaps, but a large spectrum of iron ore fines are produced and mined from as low as 30% for some of the lower-quality Chinese

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material to above 60% at the high end. The most merchantable grades lie between 58% and 65%, with key markers at 58%, 62%, 63.5% and 65%. There is a degree of correlation between prices in the 58% to 65% range, but the most linear pricing and consuming relationships lies between 60% and 63.5% ferrous content. Fig. 11: Seaborne Iron Ore Demand (Mt)

Source: BP Billiton Estimates

A simple way to look at iron ore is that it starts as fines (heavy grains, like sand), is turned into pig iron, which in combination with coking (metallurgical) coal, and energy can then produce crude (liquid) steel, which is finished (rolled) into either in long (e.g. Rebar) or flat (Hot Rolled Coil) form. Steel comes in many hundreds of specifications depending upon the requirements for the finished product. It is an alloy, or a combination of metals whereas iron ore is a mineral.

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Fig. 12: Global Iron Ore End Markets Based On Iron Content, 2009E

Source: Mineral Information Institute, International Iron and Steel Institute, Barclays Equity Capital Research

4.3 Price Relationships
Iron ore’s relationship with steel prices, with energy — Coal especially — and freight which transports it, is obvious. The relationship between the most important global crude oil benchmark and iron ore may not be the first to come to mind, but as a host to the two leading crude oil benchmarks, the logic of ICE’s entry into iron ore is underscored in the following chart: Fig. 13 & 14: Platts Iron Ore and Dated Brent Crude Price Assessments

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More directly, relational pricing can exist between iron ore and steel (known as the “metal spread”) and iron lump to steel (the “hot metal spread”). These ‘lumps’ are the intermediate stage between iron ore and pig iron.

Source: Platts

4.4 Iron Ore Market Status and Evolution
Historically, iron ore has traded under long-term contracts based on a benchmark price, negotiated annually. This approach was established under the first major agreement between a buy-side consumer of iron ore - a steel producer - and a sell-side iron ore producer - a mining company. Historically, in an environment of generally lower and less volatile prices, that agreement was then considered to have set prices for the remainder of the year, which was typically based on the Japanese fiscal years of March 31st to April 1st. However the markets have seen great structural and behavioral changes in recent years, both the consolidation and increasing vertical integration of steel producers and combined iron ore and steel producing entities, aligned with higher volatilities in price than was generally the case in former years. Benchmark negotiations between major iron ore producers in Australia, India and Brazil especially, and consuming entities in Japan formerly, but more recently dominated by China had already become more protracted, but over the 2007-2009 period the strains in the former system have become intense. The volatility of more directly and short-term market-driven input prices such as coal, energy and freight, together with the operational and financial pressures generally in markets in these years have brought the need for shorter-term consensus, market-based pricing more sharply into relief in iron and steel markets. Corporate restructuring and consolidation itself has not been enough to remove the consequent winner/loser cycle where high start up costs are required to enter such markets.

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The benchmark iron ore price has become increasingly unworkable for a proportion of the market, either so high relative to the input costs that consumers have felt justified in walking away from contracts agreed under conditions that look very different in hindsight under varying market conditions, or so low that producers struggled to see how revenue could cover their costs which rose irrespective of benchmark prices for revenue stream agreed before those input prices had risen. In short, revenue and cost pricing cycles had moved significantly, impacting contract stability for those longer-term prices. Faced with such developments, market participants have turned increasingly to the release of spot iron ore material, preferring to seek out prices that are more relevant to fast moving price fundamentals than those that existed at the time of the most recent benchmark-negotiated price. The emergence of price assessors such as Platts in iron ore and steel markets gives such participants an independent and transparent price for shorter-term basis pricing in iron ore, as a market-based solution to the benchmark issue. This is not the first time a market has seen such a development. The oil markets saw similar developments in the 1970’s as new spot markets emerged to challenge existing long-lasting but inflexible practices which had become increasingly unworkable and unsustainable. Forward or derivative markets, increased forward and spot price transparency, independent index price agency providers and the emergence and growth of a number of new spot markets were all part of those complementary processes in oil as traded volumes grew. Until the emergence of such swaps as the ICE iron ore swap, and for the above reasons, iron ore has been effectively the world’s largest commodity without a derivatives market. The ICE iron ore swap contract is the world’s first cleared iron ore contract against Platts index methodology.

4.5 Index Evolution and Platts Physical Methodologies
Platts has been assessing prices in the metals markets for more than 35 years, drawing on the tradition of its parent company, The McGraw-Hill Companies, which has covered the metals markets for over 75 years. Platts saw the fast-paced evolution of iron ore from an annual to spot market and was the first publisher to begin assessing pricing on a daily basis in June 2008. Since then, Platts has rapidly expanded its offerings for the iron ore market, which now include flat price assessments for 62% Fe and 63.5/63% Fe grades, high-grade 65% and a low-grade 58% Fe grade, as well as a daily 1% per Fe content differential for iron ore fines 60-63.5% to help clarify the normalization process. Platts also publishes daily freight netbacks based on the most liquid routes to five basis origins. A forward curve assessing the daily bid/offer and trade values in the over the counter swaps market for iron ore has also been recently introduced.

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4.6 Future Index and Benchmark Scenarios: The Oil Example
We’ve already seen a few hints that iron ore might be looking a little similar in structure to the evolving oil markets of the late 1970’s/early 1980’s. The hot metal spread is similar in concept to oil ‘crack spreads’ in the sense that they represent a pricing and processing differential between a raw and a finished product. Many integrated producers are more concerned with processing margin than flat price inputs in themselves. That is very similar to conditions in oil pricing and markets. HOW DID MODERN CRUDE OIL MARKETS EVOLVE? Fig. 15

4.7 Iron Ore and Benchmarks
If iron ore follows a similar path to other commodity (and energy) markets, the 62% Fe grade may become an important benchmark for relational pricing of other iron ore grades or even of finished products that relate to it. If that is the case, 58% and 65% iron ore may trade at negative and positive differential respectively to 62%, and steel may trade as a positive differential to it in time. What exactly is a Benchmark, and how do they function? • Benchmarks provide a standard industry reference point which is fair, market related, transparent and understood by all participants

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• Benchmarks facilitate business by providing a focal point for differential pricing of related commodities • Benchmarks enable: o Hedging - offsetting a price exposure with an equal and opposite exposure) o Price transparency - discovery/dissemination of prices in real-time

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Conclusion

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5. Conclusion

Iron ore and steel markets represent a natural extension and complement to its existing commodity and energy markets and communities of market participants. Iron ore is becoming increasingly controlled by only a few players (Vale, Rio-Tinto/BHP). Despite recently higher ore prices amid contract negotiations, it wouldn't be too bullish on iron ore over a 2-year horizon even if major players can use their high market share positions to support pricing a little bit.

BHP is keen to kill off the traditional annual price negotiations and replace them with contracts based on price indexes. Vale also discussed its decision to move existing iron ore contracts to index-based prices.

A new global growth pattern produced a major change in the dynamics of the iron ore market.

The new iron ore pricing system which involves a decision to move existing iron ore contracts to index-based prices, smoothes the natural daily spot price volatility as it establishes a quarterly iron ore price based on a three-month average of price indices for the period ending one month before the onset of the new quarter. While retaining flexibility, the system allows steel companies to be known beforehand the price to be paid in the following quarter, thus facilitating cost control and inventory management.

It will be mutually beneficial to steel and mining companies, boosting their contribution to global economic and social prosperity.

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Bibliography

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Feasibility Study of Iron Ore Futures Contract
6. Bibliography
https://www.theice.com/ (Intercontinental Exchange) http://www.usgs.gov/ (U.S. Geological Survey) http://www.ferroalloynet.com/ http://www.portal.gsi.gov.in/ (Geological Survey of India) http://www.gfms.co.uk/ (Gold Fields Mineral Services) http://www.gold.org/ (World Gold Council) http://www.imf.org/ (International Monetary Fund) http://www.unctad.org/ (United Nations Conference on Trade and Development) http://www.icexindia.com/ (Indian Commodity Exchange)

ITM Business School, Navi Mumbai, Kharghar

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