Physical vs. Futures Investment, With Copper ETFs As Primary Example

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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 cliché, 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.

–Taras Berezowsky

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Comment (1)

  1. carlo says:

    Investment Grade Molybdenum : 99.9% molybdenum bars

    Commodities are physical substances like grains, food and metals. An investment is the purchase of a financial product or other item of value with the expectation of favorable returns in the future.

    Well, I prefer metals for preservation of my wealth. The question is what metal would you pick to preserve your wealth? Now the next thing to keep in mind is not to be biased in any way. That is, to buy a certain metal because someone tells you to, or to buy a certain metal because it is on an upward price trend or buy a metal because you read an interesting article on it.

    #1 on my shopping list. I look at is a the ability of a metal to actually promote or enable life of plants and animals on this planet. This means that you can actually grow food with it or grow trees. You can actually use the metal by sprinkling the powderized form on your soil and let the microbes in the soil slowly break down the metal and make it available for the plants to consume. Hydroponic or Aeroponic growing of food uses about 17 life giving elements that are added to the water to give complete nutritional support for plants.

    Unfortunately, there are only 7 elements of the 17 needed for plants that are an actual “metal”. These are called transition metals. Transition metals are known for their ability to conduct electricity, their hardness, high density, malleability (a material that can be worked with or hammered into flat sheets), ductility (able to be produced into a thin wire).

    These 7 investment grade metals are Molybdenum, Cobalt, Copper, Zinc, Manganese, Iron, Nickel. Nickel is documented as a essential nutrient in some plants. Nickel is not used in some high-end hydroponic formulas.

    #2 on my shopping list. I now have 7 transition metals that are used in growing food and are capable of being in my metal portfolio. But, I only want one metal. I will now consider the amount of this metal available on Earth. The next step would be the abundance of the metal or scarcity of it. Here is a list of these 7 metals and the amount in parts per million in the Earth’s crust.

    Molybdenum 1 ppm Molybdenum is most valuable here because of scarcity

    Cobalt 25 ppm

    Copper 60 ppm

    Zinc 70 ppm

    Nickel 84 ppm

    Manganese 950 ppm
    Iron 56300 ppm

    #3 on my shopping list is the melting point. I want a metal that can withstand high working temperatures. There is something called metal “creep” and that is the expansion or deformation of metals when they start reaching temperatures near the melting point. I like metals that don’t creep or change shape in high temperature conditions eg: Jet engines, Furnaces or anywhere where safety is priority.

    Molybdenum has the highest melting point of any life giving metals. Molybdenum has the sixth highest melting point of any element on Earth, which is incredible!

    Molybdenum 4753 Degrees Fahrenheit Melting Point

    Iron 2800 Degrees Fahrenheit M.P.

    Cobalt 2723 Degrees Fahrenheit M.P.

    Nickel 2651 Degrees Fahrenheit M.P.

    Manganese 2275 Degrees Fahrenheit M.P.

    Copper 1984 Degrees Fahrenheit M.P.
    Zinc 787 Degrees Fahrenheit M.P.

    #4 on my shopping list. The metal is an investment so I Do Not want it to rust, oxidize or corrode. If this happens you can surely say goodbye to your investment. Molybdenum does not react with water or air at room temperature and will not corrode. Molybdenum will keep a beautiful lustre (silvery blue). Copper and iron are definitely OFF my shopping list in this category.

    Research this incredible metal for yourself, it has many uses.
    Carlo Biancardi (London, Ontario) April 2011

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