Forward prices on the LME are often misread by those not more intimately involved with the futures markets, a point that may have occurred to anyone reading an article last week by Reuters’ Andy Home, a writer with a long and close association with the metals markets and the LME in particular.
The article opens with the logical statement that LME metal prices for delivery in the future are no predictor of what prices will actually be at a future date. Rather, each metal’s forward curve is a snapshot of future expectations anchored on the current price.
Now in theory, that should, at its simplest, be a total of the current spot price plus the cost of finance, storage and insurance for the period in question. The waters become muddied when a metal is either in short supply or the market is awash with excess.
At first glance, one would assume that a market in excess may have lower forward prices because buyers would expect metal to be readily available and would see no need to buy now and hold for a future date – but in practice, the opposite is true.
As the graph shows, metals like aluminum and zinc, which have been characterized by chronic oversupply and high legacy stocks, show the strongest forward price curve.
While metals like copper that exhibit tightness of supply, both at present and expected in the future, display almost flat forward curves or even at times are in backwardation, meaning the cash price is at a premium to the forward price.
The way to interpret this is indicated by Home’s opening statement: “Each metal’s forward curve is a snapshot of future expectations anchored on the current price.”
So if a metal is in abundant supply, there is no benefit to owning it now and holding on to it. If a buyer needs to fix his cost price for metal required in the future, he may as well buy it from his producer for some forward date and pay the premium equivalent to storage, finance and insurance between now and that forward date; that price is reflected on a futures market forward price curve.
But if a metal is in short supply, there could be issues around delivery or access to metal, in which case owning the metal now has benefits.
Continued in Part Two.