Last week we ran a comparison of the LME Far East Steel Billet quotation which is in a warehouse in Inchon South Korea as well as Johor, Malaysia against Chinese steel billet prices taken from the local domestic market in China. The correlation wasn’t too bad considering there is much overlap in terms of material size and grade but not in terms of currency and delivery location. As we said at the time, the LME steel billet quotation is in its infancy and over time, greater liquidity will provide a progressively more accurate reflection of reality.
The primary reason for the LME’s existence is to allow producers and suppliers to hedge their forward price risk for the products they sell or buy. But many more products are priced based on the primary metal than just ingots, sows, cathodes or in this case, billets. So it is fair to expect that the LME Steel Billet price should provide hedging opportunities for a whole range of steel semi finished products which run more in tandem with the billet price. Some immediate examples that spring to mind are other long products such as bars, reinforcing (rebar) bars, wire products and sections. The major banks and brokerage houses would like to provide hedging services in a wider range of products like HR/CR coil, slabs, plates and tubular products. The further you get from billets downstream into these semi finished products the less likely a close correlation is going to hold true. However, that doesn’t mean a viable hedging product cannot be developed. It just takes more ingenuity. So we thought on a simplistic level we would take a look at how the LME Steel Billet price has compared for comparable dates at the month end over the first half of 2009 to a range of semi finished steel items in the local Chinese market. The graph below takes a plot of the LME price in black with red boxes ” the lowest line ” against a range of steel forms as the legend details:
The LME contract is in US$ but to make it easier we have converted the US$ price to a Chinese RMB price at the prevailing exchange rate.
As we can see, the LME price has tracked fairly well against all the products, rather perversely the closest match is to HDG (Hot Dipped Galvanized) steel coil, probably the product most downstream from basic billets among all of those tracked here. One limitation of the approach here is we have taken a single day, if we averaged data points over the last week of the month or used weekly averages as data points instead of one day at the end of the month we would iron out some of the peaks and troughs. The most pronounced divergence is the last entry where the LME goes up and nearly all the other metals go down, but when we referred back to the source data we could see the LME fell after the month end which if it had been captured in an averaging process would not have shown quite as sharp a divergence from the other metals. Nevertheless we would want to look into this in more detail if we were making a more vigorous analysis.
Bear in mind the LME is responding to supply and demand signals in the wider Asian market, not just domestic China. We will re-run this analysis when we have sufficient data from our Korean steel prices which we will be adding later this year to see how it tracks to the same delivery location at Inchon. The other issue is that once an exchange traded product is used as the benchmark for trade pricing, as the aluminum ingot or copper cathode/wire bar prices are for so many aluminum and copper semis the correlation becomes absolute and only producer conversion premiums change gradually over months largely in response to mill loadings. So in summary we can say the probability is hedging products for a range of semi finished steel products will be forthcoming in the fairly near future and their uptake will further solidify the LME steel billet’s price position as an industry benchmark.