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Markets are increasingly becoming volatile not due to demand fluctuation but excess liquidity. A single copper trader spiked copper prices at LME last month by cornering 90% of stocks. What will be the future trends?
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RISK MANAGINGTURBULENT 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
Trader
spikes
copper
During post Christmas trading a single trader at the London Metal Exchange cornered around 90% of the LME Copper stocks at its warehouses worth $3 billion which was nearly 50% of the total 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 metals followed the copper upsurge
It was not only Copper stocks at LME that were cornered by single traders in absence of restrictions at London’s deregulated markets.
Financed by Banks flush with liquidity from QE2 Aluminum, Nickel, Zinc and Tin were too spiked with single buyers cornering over 50% LME stocks at 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 CycleIs 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 investmentsas China and US stockpiles of crude at Cushing rose. The arbitrage had justvanished 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.
To hedge against losses in Copperand Metal Trade Goldman managers could soon be writing a hedging option, a derivative, within a month of recommending copper so stronglyat the Reuters Press Conference
Goldman may soon write a Copper CDS!
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
It is less informed investors who loose money, not Banks
whomanage to cover up their losses through the Fed and taxpayer largesse creating yet another asset class for sales.
For it is investors who loose money
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 pitheadsA 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 copperConsumption 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
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.
Big Banks won’t find metal markets as liquid
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.
Our Blog : Economy to Ecology: Our goal is to help promote clean, safe and better practices in economy and ecology worldwide. Balanced, efficient and a little more sustainable. Kindle Blog Ecothrust ASIN: B0029ZAUAY For non kindle users : www.ecothrust.blogspot.com
Follow us at twitter : www.twitter.com/ecothrust Acknowledgements:To Google, flickr photolibrary and other image sources.
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