Are HRC Steel Futures Poised For Rapid Growth?

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MetalMiner guest columnist Brad Clark is a senior derivatives broker who leads the St. Louis office of FIS Ltd., the London-based global commodity interdealer broker. Mr. Clark brokers physical and derivative deals on steel, iron ore, scrap and freight with a focus on the domestic US market.

With the passing of Labor Day weekend, we can finally say goodbye to the so-called “summer lull.

Why so-called? Because for the US HRC futures market, it seems, July has historically been the most active month alongside September. This year, however, we’ve seen a tremendous increase in volumes in August on the US HRC futures contract. With a stronger July for volumes in 2011 over 2010, many in the market were preparing for the historically sluggish August volumes, but this year we were pleasantly surprised. US HRC futures volumes in August were up 300 percent year-on-year for the same period last year (with the majority of trades occurring in the first half of the month).

The million-dollar question is: will September fulfill its historical promise of being one of the top two months for volumes? So far we have seen more and more interest from more and more new entrants into the market already this month. All signs are pointing for 2011 to be the best year on record for the US HRC futures market.

Let’s not delude ourselves — volumes on hot-rolled compared to more mature markets are still minuscule. On hot-rolled we speak in thousands of tons, while with aluminum, lead, zinc, copper, and iron ore we speak in millions of tons. Oil futures trade at a multiple to the underlying physical market volumes. US HRC futures still have a long way to go — but it seems there is something bubbling under the surface.

What’s In Store For HRC Futures

Increasing volatility in raw materials and uneven growth in the US not to mention global economy have created a potent mix of uncertainty that is increasing volatility in the steel markets.  This volatility began to rear its head several years ago and has grown unabated since 2007.

The increased volatility has driven many in the industry to search for a mechanism to manage the uncertainty in prices. The industry’s savviest have taken a play out of other volatile markets’ playbooks and have found a safe haven in financial derivatives products. This increased volume we are seeing this year (volumes on US HRC have increased 18.5 percent this year when compared to the same period last year) is a direct result of the increased sophistication of many in the US steel industry. This chart, taken from a CME published volumes report shows some of the growth:

Source: CME

While volumes are increasing, another more positive sign is the number of new participants entering the HRC futures market. The volumes are increasing not primarily because a handful of existing players are trading more, but rather because more and more new companies are learning how to effectively utilize the derivatives market to manage their business.

So, while we may not be at the watershed moment just yet for US HRC futures volumes, we are definitely much closer than we were one year ago. And when the watershed moment occurs, it can occur like a tidal wave. We have most recently seen this “tipping point scenario in the iron ore futures market. Where in 2009 less than 200,000 tons of iron ore futures traded the entire year, this year 3 million tons traded in May alone with the total yearly volume expected to push well into double-digit millions.

Will 2012 represent the tipping point for US HRC futures? It’s anyone’s guess, but looking to other commodity markets’ evolution and the underlying fundamentals of the steel industry, it is a question of when — not if — the futures market will explode.

–Brad Clark

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