RISK Managing

VOLATILE Markets

WHAT DRIVES PRICES?

Business Risk Management Series
BA-42: Metals
What Drives Prices?
Liquidity
or
Demand
 Big Banks enter metal
warehousing
In March 2010, Financial Times reported
that the Wall Street Banks JP Morgan
Chase and Goldman Sachs bought
Metro International a London based LME
approved warehouse operator of metals
for a whopping $550 million
 JP Morgan files for
ETF
As per a Business Week report in
October JP Morgan Chase & Co filed
an application with SEC for an ETF
where investors can trade in copper like
stocks without taking
physical deliveries of the same. ETF
Securities Ltd is another player whose
fund has 6 metals for trading at LME
 Fed Infuses Artificial Liquidity
 On November 3 the US Federal Reserve announced a $600
bn. Quantitative Easing package, that would pump $75
billion per month to boost liquidity and lift commodity and
stock markets in view of low U.S. demand. Markets have
boomed thereafter due to excess liquidity.
Goldman delay forecasts Copper spurt.

On 13th of December after Copper rose for 6 months

at spot markets Goldman Sachs forecast that
Copper Prices would outperform others as per
Reuters. The reason was attributed to an old
bogey….. high demand from China.
Single
During post Christmas trading a
Trader single trader at the London Metal
Exchange cornered around 90% of
the LME Copper stocks at its
spikes warehouses worth $3 billion
which was nearly 50% of the total
copper registered Global Stocks as per
the Wall Street Journal.
 Global
Copper
Consumption
was up by
only 4%,
but prices
shot up
by 30%
Other
Non
ferrous
It was not only Copper stocks at LME that
metals were cornered by single traders in absence
of restrictions at London’s deregulated
followed markets.

the Financed by Banks flush with liquidity

from QE2 Aluminum, Nickel, Zinc and
copper Tin were too spiked with single buyers
cornering over 50% LME stocks at
upsurge London and sending prices sky high
 But what off the demand?
So Liquidity helped corner the metal
stocks at LME
Investors were roped in as markets
boomed.
Hence prices shot up at Christmas time
when physical deliveries are traditionally
the lowest.
 
What were stock levels?
 High Stocks At LME
Warehouses
If there is a
real demand of
metals
worldwide why
was
inventories at
LME at an all
time high as
per Citigroup?
 High Production
Low Off Take of Copper
 
 
Global Copper production capacity
of 23 million tones is much higher
than Global consumption,
dropping each year since 2004
Growing copper mining
 Big buyer China
has stockpiled
China which traditionally consumed 1.5
million tones per annum stockpiled heavily in
2009 importing 3.18 million tones of refined
metal when copper prices had dropped to
$3000/ tone. Bloomberg reported that off
take has halved since but Shanghai has
higher inventories than LME
 Understanding
copper’s manufacturing
cycle
 
The “pit to user” cycle of copper is 3-5
year period unlike oil which is much
shorter at 6 -12 months. So investors
pumping money into copper without
knowing the manufacturing cycle may
be in for a long haul.
The Copper production
cycle
 The Copper Cycle
Is Complex And Long
 
The cycle time of copper
procurement is long and gives room
to delay for purchases. High prices
even helps the alloying and
recycling market to grow and cut
back on fresh copper consumption
and reduce costs.
 China moved early, built
strategic reserves
 
China, the largest consumer would buy
copper long term, for infrastructure
and energy projects.
Hence China build its copper reserves
in 2009, and may choose to avoid
global buying at high peaks now.
 China May Have The Last Laugh
 
Investors searching quick profits may really be
on the back foot and China who stockpiled
early have the last laugh.
Chile, Peru, Congo are witnessing Chinese
companies entering the mining segment
through unique barter deals despite resistance
of the IMF and the Paris Club. They are creating
a greater installed capacity and much larger
“ore to China” inventories than forecast data.
Investors have panicked before
 
In the month of July to Sept 2010 investors
panicked and fled from oil investments
as China and US stockpiles of crude at
Cushing rose. The arbitrage had just
vanished from 3 month future longs and cost
of storage made even Morgan
Stanley disinvest.

As a result hedge funds turned bearish on oil

futures for the first time in four years
reports Bloomberg.
Investors could flee again
 
It is quite possible that metals will also see
such bear markets soon, especially as retail
and consumer sales is just not present in
metals as in oil, making stocks only a long term
asset . Copper demand in China has been
relatively weak during 2010 as expected and
there is no other economy which can sustain
the demand.
Goldman may soon write
a Copper CDS!
 
To hedge against losses in Copper
and Metal Trade Goldman managers could
soon be writing a hedging option, a
derivative,
within a month
of recommending
copper so strongly
at the Reuters Press
Conference
Will investors be sucked into
storage business
 

To profit from metal trade especially

copper, investors must be ready for a
minimum time cycle of 5 years. Metals
could be profitable, but only if you
invest at the down cycle and are in the
long term storage business conducive
to manufacturing. Unfortunately we are
now at a 10 year peak !
 Metals ETF is not for
the faint hearted
 
If you are investing in metals
plan to invest long term.
And if you do plan, long term
stocks may be an better option to
ETF warehousing business,
which could be very extended.
 Investors must learn
to manage their Risks
 
It is not the business of Banks to do the risk
management of your investment.
Housing was just a sample .

They are only geared to sell the various

investment products and at best give a
trend forecast. Delayed Forecasts often
trap investors as Banks liquidate positions. 

It is the investors who must understand and

manage risk and not leave it to Fund Managers
For it is investors who loose money

It is less informed investors who

loose money, not Banks who
manage to cover up their losses
through the Fed and taxpayer
largesse creating yet another
asset class for sales.
The two dimensions of Risk
There are two dimensions
to every risk in the
modern day world

The technological
and
the financial
Investors must study both
components of Risk
The technological risk is often a
manufacturing process phenomenon
which most financial managers
wrongly assess.

Banks normally forecast based on

financial trends.

Investors must study both

components of Risk themselves for
safety.
Hedges give little benefit

Manufacturing Companies
need not hedge against
copper prices. They must
wait and reframe their
buying schedules to the
next quarter as the fresh
round of QE2 liquidity re-
adjusts to new investments
Buying from mining pitheads
A third of the world’s produce of copper is still
unregistered and available at pit heads at very
attractive prices.

They are but available only on pay and lift

basis being in politically sensitive regions and
only those with piles of cash can still make hay.
 Turning Copper threat
into opportunity
Efficient Recycling is the most effective of the
six methods to reduce Copper prices.
There are endless opportunities from
professionalised scrap collection to classified
segregation, testing and recycling and
reprocessing.

Since the last 50 years scrap usage in copper

has hovered around 35% when it can go up to
50% considering that over 300 million tones of
old copper scrap ( non-radio active) is
currently available globally.
Efficient Recycling helps reduce consumption

One reason why copper

Consumption forecasts remain
unpredictable is because of the
role of recycling of scrap and
continuous technology
breakthroughs in the processing
and recycling industry of late
that is making major producers
like Germany, Japan, China
Belgium and Russia use less
copper concentrate each year
Big Banks won’t find metal markets as liquid

After the credit crisis the Big Banks did fairly well
playing in the markets with TARP funds for profits.
However metals are high value assets which are
not liquid. ETF may not make metals liquid.
Volatility in copper has been historically observed
coinciding with the economic cycle, showing that
purchases are made during cycles of affordability
and can be deferred.
 Copper Prices Have Surpassed
Even The 2008 Asset Bubble Peaks

Copper Prices Have Surpassed Historic Highs

 How Long Can Liquidity
prop Prices ?
 
With US Housing showing no signs of
revival, the Banks and investors are
playing with limited firepower .
The 2008 peak copper price has been
breached but it is unlikely that it can be
sustained for the next 3 months.
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References:
WSJ, Business Week, Bloomberg, Financial Times, ICSG, Metal
Prices. Com , Kitco, Citigroup, Guardian, Telegraph, mongabay .com,
Reuters and London Metal Exchange and Ecothrust.

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