How Closely Does the LME Steel Billet Contract Correlate to the Local Asian Market?

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Ferrous Metals

The London Metal Exchange has released an audited volumes report for its steel billet contracts for the first 6 months of 2009. According to the LME report, 12,284 lots were traded in the first 6 months of 2009 representing 798,460 tons of material with a value of USD 263.4 million. We thought it would be interesting to review how well the new contract has been taken up and how the prices reported daily have compared to existing markets in the Far East.
In the LME report, the monthly trade volumes in lots in the first half of 2009 are as follows:

lme-steel-table.jpg

The number of approved steel brands which can be delivered against the contract has risen to 41 and since its inception, financial market participants have been watching the contract to see if they can offer hedging services on the back of the LME’s first steel contract. The issues for firms offering hedging services are many fold but one key element is how closely the futures contract tracks real world trades. LME contracts allow physical delivery of metal and as such should be a good reflection of the physical market but the contract is still in the early stages of up take. Liquidity is relatively thin compared to established contracts like copper or aluminum and certainly in the early days we saw the LME steel billet price going in one direction while the physical market went in another. As the table above shows, liquidity as measured by number of lots traded is gradually growing. And with a rising number of brands accepted, it would appear producers at least are beginning to embrace the concept of market participation.

So we thought it would be interesting to see how the LME Far East contract compares to the MetalMiner IndX Steel Billet price quotation as reported daily from China. Any hedging services would need a good correlation between the LME price and local market prices over time in order to be of value. Now to be fair we should point out the LME contract calls for steel billets to be delivered in Incheon, South Korea or Johor, in southern Malaysia whereas the Tangang China steel billet market is a domestic China price so direct comparisons of prices converted into dollars could include distortions of exchange rate or local taxes like vat etc in China. For that reason we have taken the original RMB price of the Tangang market rather than the dollar equivalent price available on MetalMiner IndX because it is the trends we are looking to view not the absolute price. Both contracts allow for 150 x 150 mm billet sizes although the LME contract does also allow smaller dimensions down to 100 x 100 mm, again this should not be an issue when looking at medium term trends.

lme-steel-billet.jpg

As we can see the prices have correlated very well and should improve with time as liquidity in the LME contract increases. There has been a divergence in the very last price point but remember these are single day prices not averages so its quite possible that the markets could diverge for a day or so and them come back into correlation. MetalMiner will allow an even more accurate comparison later in the year when we add Korean market prices to the MetalMiner IndX, with the LME reflecting Incheon prices and MM reporting domestic Korean prices there should be minimal divergence. The question now is how accurately the LME Billet contract matches movements in related steel products like steel wire, bars, reinforcing bars and tubes. That will be the subject of a further analysis this week and will be the area banks and brokers will be looking at to sell hedging services.

–Stuart Burns

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