Much of the hoopla surrounding the copper, tin and nickel ETPs released last December stems from the convergence of the speculative concerns of traders versus industrial buyers’ demand for the metals. And although the ETFs themselves have drawn a lot of media attention, it’s still relatively a small part of the industrial supply/demand equation. The truth is, while explosive growth in emerging markets spurs never-before-seen price increases in commodities such as food, energy and base metals, investor interest in commodity ETFs has grown proportionally, with raised concerns about hedging against losses and behavior that appears reminiscent of the precious metals market.
“The cyclical recovery story is a big one, said Scott Thompson, co-head of European sales for ETF Securities in a conference call Thursday. “Demand [is] coming from China and India, from infrastructure and real asset investing, and that is what clients look at when investing in industrial metals.
Thompson’s basic mantra (and that of ETFS) is to obviously raise interest in and buy-ins of their products, which include the first physically backed base metal ETFs. In drawing the pros and cons between physical vs. futures investment, he makes the case that because returns on futures contracts have historically been exposed to more volatility, it may be the best time to invest in the physical metals. (Arguably, Thompson said, the best time to traffic in futures contracts, using copper as an example, is when the market is in backwardation i.e. when you’re gaining positive roll yields due to lower futures prices against the spot.) The two graphs shown below highlight the difference in volatility in carry costs and returns for copper, respectively:
Courtesy ETF Securities; data from LME and DJ UBS indices
Courtesy ETF Securities
Storing the physical metal has always been a sticking point in making the sell to investors it simply seems cumbersome. The main reasons Thompson gave for physical investment centered on knowing in advance from the LME warehouses what your metal storage costs will be. So if that transparency is one’s investment goal, along with having access to an LME-regulated and audited environment, and playing it safe with low variation year-to-year, then perhaps physically backed is the way to go, he said.
From our perspective, the fundamentals for copper look good, although some investors seem to be getting more cautious on the short-to-medium term outlook due to inflation-related issues in China, including housing prices slightly slackening demand for base metals. Reuters reported recently that ETFS’ physical copper stocks dropped significantly last week, falling by 35 percent since the end of January, to 1,350 tons total. (This is reportedly still “only a fraction of LME inventories, which stand at 400,000 tons of copper.)
Interestingly, tin activity is what’s hot, as Andy Home wrote in another Reuters article, saying that ETFS’ tin holdings recently doubled to 405 tons and overall LME tin stocks rose nearly 9 percent in contrast to perceived global supply shortages, but that “LME tin stocks are going to start coming under pressure sooner or later. Home continued: “Tin may prove to [be] the first battleground for diminishing metal availability between traditional users and a new breed of base metals investor.
What Home hits on there is what truly hits home. (I couldn’t resist a bad pun and clichÃƒÂ©, all in one sentence!) In all seriousness, we’ll begin to see these two markets physically backed and futures-oriented coming together in complex ways in the coming year and beyond, according to Scott Thompson. With scrutiny of risk assets increasing, he expects greater coverage of “more cyclical commodities as well as some foreign exchange and equity trends coming out over the next couple of months.
MetalMiner and its sister site, Spend Matters, along with Nucor, will host a live simulcast, International Trade Breaking Point on March 1, 2011. If your company sources products from overseas, you will not want to miss this half-day event: