Articles in Category: Investing Hedging

Crude oil hit new multiyear lows last week after the Organization of Petroelum Exporting Countries’ meeting in Vienna last week failed to address a growing supply glut.

Crude Oil Hits lowest level since 2009

Crude oil hits its lowest level since 2009. Source: @StockCharts.com

Although many people believed that oil prices had found a floor earlier this year, we didn’t subscribe to that view.

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The latest decline suggests that further declines might be around the corner. Low oil prices have a double negative effect on commodity prices:

  1. Oil is  not just a commodity, itself, but an asset closely followed by commodity investors. Falling oil prices make investors move away from commodities and, of course, industrial metals.
  2. Oil is the main benchmark for energy prices. Lower energy prices mean lower transportation costs and lower production costs, especially for those energy-intensive metals like aluminum.

For these reasons, it’s not strange to see that the trend of industrial metals looks very similar to that of oil prices:

Industrial Metals ETF

The Industrial Metals ETF is going the same direction as oil. Source: @StockCharts.com.

What This Means For Metal Buyers

The recent decline in oil prices is just another indicator hinting that metal prices will continue trending lower as we enter 2016.

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The December Aluminum MMI index fell 3% to 70 points, yet another all-time low.

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Aluminum prices fell in November, although they held much better than other base metals such as copper or nickel. Still, three-month aluminum on the London Metal Exchange hit a new low at $1,432/mt. As with the rest of the base metals complex, a strong dollar is driving prices down.

Aluminum_Chart_December-2015_FNL

In market news:

China Is Still Overproducing

According to the latest data, Chinese aluminum output has risen 18% on the year to date despite falling demand. This has led to a 14% increase in aluminum exports this year (to date). One of the reasons China doesn’t cut production is its smelters’ ability to withstand low international prices.

Recently, China’s government announced its plans to introduce more competition into its power sector that could potentially lower electricity prices there. Given that power makes up 40% of the cost of producing aluminum, Chinese smelters’ margins would significantly improve on lower electricity prices.

Chinese smelters this year already pressured domestic power companies to reduce electricity tariffs and some smelters have managed to reduce costs by 35%. In addition, energy prices keep falling. Crude oil, a good benchmark for energy prices fell yesterday near seven-year lows.

Rio Tinto Bets On Bauxite Prospects

While major companies are delaying new mines as prices slump, in November Rio Tinto Group approved a $1.9 billion bauxite project in northeastern Australia. The company is more optimistic than most, as it expects a rebound in demand in the short term, meaning the next three years. The mine is expected to open in 2019 with an annual production of 22.8 million metric tons of bauxite, the raw material that is used to make alumina, a key ingredient in the production of aluminum.

China To Buy Up Aluminum

It is said that China will stock up its aluminum reserves by buying 900,000 mt of aluminum at current prices to reduce the oversupply that has battered markets. This seems like a bad idea, just like Beijing’s poorly thought-through intervention in the stock market last summer when it stepped in to buy shares to prop up the domestic market.

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Most likely, the actions will only produce a temporary price boost if anything. Also, it could be counterproductive as it might encourage mining companies to put off the needed production cuts, prolonging the market pain.

What This Means For Metal Buyers

Aluminum prices continue to trend lower. Current macro-drivers keep suggesting more market lows to come. China’s action to rebalance the market looks like a sign of desperation, suggesting that a sustainable price recovery is not around the corner.

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Last Thursday was a big day in currency markets. The dollar fell sharply against other currencies while the euro saw its value rise.

Dollar Index falls on ECB and Fed talks

The US Dollar Index falls on ECB and Fed talks. Source: @StockCharts.com.

The European Central Bank disappointed investors after presenting a package of stimulus measures smaller than expected. The ECB surprised the market as many expected the central bank to bring stronger stimulus measures, including a larger cut to the deposit rate which was cut only by 10 basis points to 0.3%, quite a smaller cut than what most investors expected.

On top of the disappointing stimulus measures, the Federal Reserve said that rate increases will come but they are likely to follow a gradual path.

The Fed sees a strong dollar and low inflation as contributing factors to proceed gradually on rate hikes. Therefore, although a rate hike is still expected in December, the diverging monetary policy between the US and Europe seems to have narrowed after the talks.

In theory, higher borrowing costs domestically make the dollar more attractive to investors seeking yields than other currencies. Based on how markets reacted on Thursday, investors might have lost a bit of enthusiasm on the dollar after the Fed and ECB talks, which could throw some cold water on the dollar’s current bull market giving some short-term support to metal prices.

What This Means For Metal Buyers

So far, this is only a one-day decline and buyers need to focus on the big picture. Longer term, things are still pointing to a strong dollar and depressed commodity prices. A smaller stimulus by the ECB doesn’t seem to be enough to stop the dollar from rising as we move forward, but it is something to keep an eye on.

After 2 months holding steady at 59, our Stainless MMI sank in December to 54, 8.5% down from last month.

Three-month nickel on the London Metal Exchange fell in November to a new 12-year low, falling as low as $8,145 per metric ton. The metal is the biggest loser on the LME this year, losing around 45% of its value on the year to date.

Stainless_Chart_December-2015_FNL

This brings up the question: is there still downside potential?

Just a year ago, when nickel was trading near $15,000/mt most analysts only saw upside risk and little downside potential. Since prices were trading at a 50% discount from nickel’s peak in 2011, and half the producers were already underwater, how much lower could prices go?

They Can Go Lower

Well, so far, from $15,000 to $8,500 that’s a 44% decline, there you have your “downside potential.” Why do people make the mistake of buying low only to see prices go even lower? Behavioral finance calls this “anchoring,” the human tendency to attach or “anchor” our thoughts to a reference point even when it makes no logical sense.

When buyers see that nickel prices have fallen significantly and quickly, they anchor the new low price onto a recent price high that nickel previously achieved. This creates the idea that the new price provides an opportunity to buy nickel at a discount.

Most of the time, how high the metal was trading before is irrelevant and we can’t just say that something is undervalued when there has been a change in the metal’s underlying fundamentals. The poor outlook for struggling steel and stainless sectors, as well as China’s slowing growth, kept a lid on a nickel price increase this year. Finally, a surging dollar in November triggered a new sell-off, driving the metal to record lows.

Low prices keep putting more and more pressure on smelters. Toward the end of the month, nickel smelters in China announced plans to cut output next year by at least 20%. The smelters didn’t state how much nickel that 20% actually is, but analysts estimate it to be near 120,000 metric tons. Eight producers already agreed to cut output in December by 15,000 mt. It’s estimated that 70% of global production is now loss-making production.

Will the new production cuts lead to sustainable higher prices? We’ll have to wait and see how the market reacts. So far, price rallies have been short-lived and given the poor commodity macro outlook, we can’t mark a limit to the downside.

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The London Metal Exchange (LME) launched three new contracts this week — LME Aluminium Premiums, LME Steel Rebar and LME Steel Scrap, the first new contracts to be offered by the Exchange in more than five years.

You can now hedge aluminum physical delivery premiums using an LME contract. Source: iStock.

You can now hedge aluminum physical delivery premiums using an LME contract. Source: iStock.

The two steel contracts are cash-settled against physical Turkish scrap and rebar price indexes as opposed to the current steel billet contracts that are settled by physical delivery and have largely proved to be  a failure since launch.

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Why, we might ask, would these new contracts prove anymore successful? Well acknowledging the failure with billet, the LME has worked assiduously to garner industry support both in the shaping and specification of the new contracts. Goldman Sachs, for example, is on the LME’s steel committee and major trading firms like Stemcor have publicly stated they intend to be actively involved from day one, although they still add the caveat “subject to market conditions and liquidity.”

Liquidity was always a major issue for the billet contract. It never secured anywhere near enough interest from the trade to generate sufficient volume and, hence, a fair market price.

Rebar and Scrap

The steel scrap and rebar contracts will be traded on LME Select in small lots of just 10 metric tons making them more accessible for smaller market players, while, at the same time, the LME is offering discounts for volume trades to encourage liquidity. Read more

In early October I received a phone call from a well-known consultant/advisor within the domestic steel industry. He wanted to know if we were urging our readers to begin to hedge steel (meaning immediately hedge, as opposed to creating a hedging program).

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My gut reaction to the question was to dodge it because I wanted to understand why he asked it. Our conversation went along the lines of this:

Him: Hi, Lisa. I heard you speak at the recent Steel Market Update event. I was just wondering if you were urging your readers to hedge steel.

lisa reisman

MetalMiner Executive Editor Lisa Reisman

Me: Why do you ask?

Him: I think there is a lot more steel price upside risk than downside risk.

Me: I don’t disagree with you, in that prices are on the low end of the range relatively speaking, but in answer to your question, no, we are not telling our readers to hedge right now.

Him: Why not?

Me: Because we don’t see signs of a market bottom. Prices would have to stop falling and begin rising, crossing certain levels before we’d suggest companies hedge.

Him: So you don’t see upside risk?

Me: We don’t try and time the absolute lowest point of the market and then lock-in. We try to identify when the trend has shifted (from bear to bull) and take cover, then buy forward or hedge. Until we see evidence of a trend shift — and the market still looks negative to us —we don’t pay much attention to upside/downside risk, per se. It’s not relative in driving industrial buying behavior.

Source: Adobe Stock/Yury Zap

Source: Adobe Stock/Yury Zap

Is This Analyst Wrong?

That’s probably somewhat of an irrelevant question. He can be both right and wrong. Right in that, yes, there is likely more upside risk (e.g. steel can likely go a lot higher vs. a lot lower) but from an industrial metal buying perspective — I give it the big SO WHAT? Read more

There is much debate about how much further copper prices have to fall. The LME Copper price dropped to $4,590 per metric ton on Tuesday and has recovered only slightly since. It is now at its lowest level in six years and, according to ThomsonReuters, some analysts are suggesting it could fall to $4,000 per mt, that is apparently Glencore’s worst-case scenario and the number they are cutting their cloth to live with as part of their ambitious debt reduction program.

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Not all producers are willing to join Glencore and make cuts. Bloomberg reports Codelco is saying it won’t cut copper production as prices slump. Speaking at the Metal Bulletin conference in Shanghai, Codelco’s CEO is quoted by the paper as saying he would rather rein in costs than curb output; noting that “if we suspend production then it’s difficult to restart.”

Goldman Sachs is Still Bearish

Goldman Sachs is quoted as saying the bear cycle in copper has years to run, predicting rising global surpluses through 2019. The growth in China’s demand will slow to 3% a year from 11% in 2013 as the government shifts the focus from investment spending to consumer demand and services as the main driver of the economy. Read more

Part of the reason China’s economy has slowed is as a result of deliberate policy actions taken by Beijing to steer it from investment-led, export-orientated manufacturing toward a model based much more on domestic consumption.

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The result has not been great for resource companies or economies around the world, but it will, in the long run, be a more sustainable model for China, and indeed for the world. China’s super-cycle was unsustainable in the medium- to longer-term, the sooner it was curtailed the lower the long-term fallout was likely to be.

But there is another reason investment growth has slowed, not just in China but in virtually all emerging markets and that is because the US and other mature economies have on the whole reined in quantitative easing.

An article in the Financial Times states that as the Federal Reserve has purchased US treasuries, driving up bond prices and driving down yields, banks and pension funds have taken low-cost loans from recipients of those treasury sales — the banks — and invested them in higher-yielding assets, mostly corporate emerging market debt.

Emerging Markets

By some measures, the article says $7 trillion of quantitative easing dollars have flowed into emerging markets since the Fed began buying bonds in 2008, and that is before adding in QE from the UK, Japan and, more latterly, the European Central Bank. The FT quotes Andrew Hunt of Andrew Hunt Economics when it seeks to explain where those funds have gone and the impact all that loose money has had on emerging market debt levels, and I quote in part as follows.

Source: Financial Times

Source: Financial Times

How QE Money Gets To Emerging Markets

There are two main routes by which QE money reached emerging markets. One involved the Fed buying US treasury bonds, as outlined above, which results in savers going in search of higher yields — such as in mutual funds buying corporate and emerging market debt. Read more

Over the past 2 months, the decline in Chinese shares has stopped.

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After a huge fall during summer, China’s stock market is performing better and that is bringing some optimism back to the market. Perhaps, too much optimism?

Shanghai Composite Index year to date

Shanghai Composite Index this year to date. Source: MetalMiner analysis of @StockCharts.com data.

In a recent article in the Wall Street Journal titled “China enters a bull market” the newspaper calls this two-month rally a bull market. With all respects to the author, Cheng Dong, describing this bounce from its lowest level as a bull market only demonstrates a complete lack of understanding of what a bull market is. Indeed, the Shanghai Composite Index already rallied 24% in July only to fall again to new lows. Read more

A recent Financial Times article made an interesting comparison between our current fall in commodity prices and falls following previous price peaks.

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The FT says that after commodity prices peaked in 1997, it took 21 months to arrest that fall. In 2000-01 it was 13 months. After collapsing, along with the global economy in 2008, commodities hit the floor in just eight months.

Source: Financial Times

Source: Financial Times

This time, the Bloomberg Commodity Index has been in decline for four years and counting. From its most recent peak in May 2011, the benchmark is off by half and scraping the lowest levels of the 21st Century.

Picking Market Bottoms

When will it hit bottom and what will that look like? This graph is what a recent Economist Intelligence Unit report suggests the trend may look like. Yet, you have to ask, in a world expecting the imminent rise in Federal Reserve interest rates, with high levels of corporate and state debt and variable levels of growth around the world are we really going to move from a state of volatility to a situation of slow benign gradual price movements for the next 2-3 years?

Source EIU

Source: Economist Intelligence Unit

The FT article and the EIU report tend to look at the issue from the asset class point of view, suggesting recent cuts in output by major producers, such as Glencore in metals and ExxonMobil in oil, will work their way through to support prices next year. But as metals consumers, we know only too well that a metal is capable of going in one direction and another is capable of going in the opposite if the fundamentals are sufficiently diverse.

Unprofitable Metals

Prices for many metals are probably close to the bottom simply because the current market price is below the cost of production. Glencore has not curtailed production of copper and zinc out of altruism, it has done so because the mines it closed are not economically viable.

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Without courting innuendo, I am not going to enter into a long evaluation on the shape of bottoms and whether we can a expect sharp pointy one or a big, fat flat one, the reality is the shape will depend on the particular metal’s supply and demand fundamentals, and investors’ view of those fundamentals.

Check out part two of this article, featuring Stuart’s analysis of the oil market and several metals.