MetalMiner would like to welcome guest columnist Brad Clark 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. Prior to joining FIS, Brad was head of dry freight derivatives trading at Trafigura, one of the world largest metals and oil traders, based in Lucerne Switzerland.
By adding some coverage of futures markets, we hope to shed some light on the world of futures and swaps trading in the iron ore, US hot rolled coil, North and South Europe hot rolled coil markets and the Turkish scrap market. My goal is twofold – to help educate as well as market futures to the US steel industry…I do have a dog in this fight, but I believe wholeheartedly every word that I write on the subject.
On the non-ferrous side, softs and agricultural and oil commodities, futures markets have become an ingrained part of doing business from both a risk management/hedging point of view and from a speculative proprietary trading stand point. But on the ferrous side, futures trading represent a new concept. As a new concept, futures trading to the steel and scrap industry along with the use of derivative products tend to conjure up a number of misconceptions and negative connotations. We hope to demystify derivatives and to provide a platform for discussion on how to properly use financial derivatives products to manage risk in markets with growing volatility. Though many would have one believe derivatives serve as the financial weapons of mass destruction, we’d argue they have their place and time. Derivatives serve as one tool in the toolbox to both manage risk and [potentially] to make money. We’d argue derivatives in and of themselves, don’t contain risk. Rather, how users make us of them creates the risk.
By Way of History
Futures markets do not represent a new field of services. In fact, farmers in the 1800s in the Midwest of America have effectively used futures to manage cash flow and plan for next year’s crop. In the coffee houses of Amsterdam in the 1600s traders used futures to speculate on the riches the “new world held. Today the steel industry represents one of the last outposts of a de facto futureless market in the commodity space.
A Word on Volatility
Futures markets do not create volatility in the underlying physical market. Futures markets evolve out of volatile physical markets. Derivatives made their way into agricultural commodities out of need, not by accident. These markets, due to their exposure to climate and weather patterns did and do remain inherently volatile. The physical users (farmers) of these markets needed a tool to manage this volatility and thus the creation of a futures market.
Unfortunately, the term “speculators has a negative connotation. Anyone involved in the physical steel industry can attest to the increase in volatility since 2003. A speculator however may prove a best friend. A speculator will take the risk created by the volatility off the hands of the buying organization, thereby offering protection against the volatility. For the daring individual, one can increase profits if the individual has greater knowledge of the markets than outside speculators. That individual can take the other side of a trade based on market knowledge. Either way, speculators provide liquidity to the market and take on risk from the market. They do not add risk to the market.