Lehman Brothers Study: I Don't Think So….

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I love articles that really make you think. So I particularly reveled in an article that appeared last week in the Financial Times claiming, “new research shows demand from industrial users has spurred a price boom in a range of metals.” I immediately double checked the date of the article to make sure it wasn’t some April Fool’s joke (it wasn’t). I’m assuming that this finding was to contradict the widely held notion (including that of the editors of this blog) that speculative investors and “the stupid money” is what is causing this metals commodity boom.

The article highlights a number of different pieces of analysis. To wit: iron ore and cobalt have risen faster than copper, which is traded on exchanges, according to Lehman Brothers. In addition, ferrochrome, cobalt, molybdenum, magnesium, rhodium, hot rolled steel, iron ore and alumina are all traded over the counter amongst traders, producers and consumers. It is these metals in particular that the article points to that are not easily accessed by speculators and thus the 598% price increases for non-exchange traded metals far exceeds the 246% price ascent for the exchange traded metals. The metals were analyzed from January 2002 to early this year. The article claims that ‘supply and demand factors, as opposed to financial flows are behind the boom in prices’.

The theory, from Michael Widmer of Lehman Brothers suggests that because speculators can’t readily gain access to the non-exchange traded metals, something else is causing the price surge. And that something else, according to Widmer is “fundamentals”. Fundamentals in this case refers to supply and demand. We have reported on many of these supply disruptions from cobalt, to ferro chrome to gold, platinum and aluminum. And it is true to say that demand is not “all quiet on the western front” but it certainly has fallen off for sure (ask your nearest metals distributor) though demand in China is still robust (yet growth is down from last year at the government’s behest). The point being, we believe it has largely been supply disruption that has caused the price increases for many of the non-traded metals and not demand or the word that we would use, consumption. We are not suggesting that “fundamentals” has no correlation to the price of metals – we are just saying that speculation likely has a more causal relationship to the commodity boom. (Please pardon the statistical references)

There are many reasons to suggest why non-exchange-traded metals saw a much bigger price increase than traded metals. For one, several of these markets are highly concentrated. A supply disruption for ferro chrome such as an energy shortage in South Africa would have an enormous impact on price since over 70% of the world’s ferro chrome originates from South Africa. We won’t go through each metal one by one here.

The facts please…

Consider the case of Red Kite Metals the world’s biggest industrial metals hedge fund. According to this recent Boomberg article, copper increased in 2006 by 44%, though consumption rose by only 2.3%, according to the International Copper Study Group. Red Kite, according to the article, “moves markets via the huge trades it executes”…as suggested in a prospectus the fund was borrowing 6x it’s investment pool, which was estimated at $1b. Converting that to metric tons of copper, that would equate to 750,000 mt (taking the March 20 price), according to the same article. Speculation does not only occur on the futures markets of course. Red Kite’s strategy is often to buy up production and/or the stocks of major producers and then sell to LME traders. The effect of these strategies of course is to reduce world inventory, hold and eventually, raise prices. Hence a commodity boom.

Of course all of the mutual funds, hedge funds etc point to research to suggest that the market moves according to the fundamentals. Frank Holmes, CEO of US Global Investors said the same, “We see the growth story in emerging markets as the key long-term driver for copper, nickel and other commodities.” But the reality is that money invested in commodity hedge funds went from $15b in 2005 to $55b in 2007, according to Cole Partners Asset Management. Mutual funds that track commodity indexes also increased from $25b in 2003 to $125b in 2007.

Now you tell me, what has caused this commodity price boom? Hmmm….

–Lisa Reisman

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