Trading minerals and metals Olle Östensson, Caromb Consulting

Outline of presentation

• Location of production• Globalization and the rise of the South• Trading minerals and metals• The 2007/8 boom and bust – and the 2009

recovery• Price risk management• Minerals and the international trading system

Factors determining location of production

• Geology• Technology: example, new copper extraction

technology (SX/EW= solvent extraction and electrowinning) turned the trend for copper producers in the United States

• Transport costs

Changes in transport costs have shifted comparative advantage

• Changes occurred in two spurts: – in the latter half of the 19th century; – in the 1950s, but its effects came to fruition only in the

1970s. • Each involved globalization of additional markets for

commodities which until then had had no more than a local or regional reach.

• Globalization involves not only increased trade flows across oceans and between continents, but also, importantly, a convergence of prices across regional markets.

Transport costs, continuedThe first shift

The application of steam power:Overland transport by oxen, horses and camels was switched to railways, and metal steamships replaced wooden sailing vessels.

Cost of shipping cotton and wheat from New York to Liverpool in constant (1910-1914) dollars per ton:1825: 55.1 1857: 15.7 1880: 8.6 1910: 3.5

In the 1850s, two thirds of British bread consumption was based on domestic cereals; by the 1880s that proportion had shrunk to 20%.

Transport costs, continuedThe second shift

• Triggered by the closure of the Suez canal in the mid-1950s. • The shipping industry opted for specialized huge bulk carriers

to permit economic transport of low value products like iron ore, steam coal, bauxite and oil across vastly extended distances.

• Result further dramatic decline in the cost of shipping, particularly for transoceanic transport routes.

• Freight rates for Brazilian iron ore to Europe declined from $24 per ton in 1960 to $7 in the early 1990s.

• The freight rate as a proportion of total price for US coal in Western Europe was reduced from more than 30% to less than 15%

Transport costs vary: freight rates for iron ore 2001-2010, US$/ton

Source: UNCTAD, The Iron Ore Market 2009-2011

The main trends in recent years

• Globalization and the internationalization of supply chains

• Chinese growth and the increasing economic weight of the South

• South-south trade

Globalization and trade liberalization

• Supply chains have become global as result of:– Reduced tariff barriers, – Better logistics– Internationalization of financial markets

• China entered WTO and obtained access to world markets• The Chinese labour force shifted from rural farming to urban

manufacturing; this made possible a dramatic increase in productivity and lower real prices of manufactures

• Results: – growing world trade without losers (until the recession)– rising real prices of commodities

Developing and emerging countries are overtaking developed ones in

total GDP

Shares of world GDP at purchasing power parities (per cent)

Source: IMF, World Economic Outlook Database

Implications

• The relative economic weight of developing countries is increasing

• Since countries at lower income levels use more commodities per unit of GDP this development is particularly important for commodity markets

• Demand growth is likely to be robust and South-South commodities trade will become even more important

Copper usage per capita in selected countries, 2007

Country Kg per capitaChina 3.5India 0.4Japan 9.8France 6.9Republic of Korea 17.0Russia 4.7United States 6.9Zimbabwe 0.7

Source: International Copper Study Group, 2007 (copper usage), UNCTAD Handbook of Statistics 2008, table 8 (population).

Intensity of use and income

Shares in world exports and imports of ores and metals, %

Region 1995 2000 2006Exports: Developed countries 61.6 59.5 52.3 Developing countries 29.1 30.6 39.7 China 1.9 2.3 3.7Imports: Developed countries 69.8 69.1 62.0 Developing countries 26.9 27.2 35.4 China 2.5 4.1 9.9

Source: UNCTAD Handbook of Statistics 2008, table 2.2A

World’s largest mineral exports and importers, % of total

Source: UNCTAD Handbook of Statistics 2008, table 3.1

A categorization of minerals markets

• Mineral products that are standardized and traded on the basis of reference prices established on commodity exchanges– Examples: aluminium, copper, gold, lead, platinum, silver, tin

and zinc• Mineral products that are less standardized and sold

directly by producers to consumers, with pricing often based on a benchmark or reference price– Examples: iron ore, chromium, manganese, phosphates and

potash• Less standardized minerals that are commonly marketed

through traders, sometimes priced on the basis of reference prices– Examples: cobalt, tungsten

Price fluctuations Price indices for nonferrous metals, January 2005-May 2009

(January 2005=100)

The 2007/2008 boom and bust

• Prices were pushed up by fast growing demand, mainly from China and other Asian countries

• Eventually this led to price “spikes” when stocks reached very low levels

• For most commodities, the price boom ended before the onset of severe recession, but the financial crisis in the autumn of 2008 exacerbated the situation in three ways: – the fall in economic activity led to lower demand– processors everywhere drew down stocks, and – the difficulties in obtaining trade finance led to a freeze in

trade.

The recession: Commodities as a buffer

• The massive Chinese demand stimulus was transmitted to the rest of the world economy through commodity imports

• As a result, the recovery was faster than expected• Commodity markets were also buoyed by the fact that

capacity was still close to the long term production trend

Production increase Jan-Feb 2010, year-on-year

Automobiles 89.7 %

Washing machines 47.5 %

Refrigerators 45.8 %

Air conditioners 27.7 %

Commodity prices fell steeper but rebounded faster

Source. IMF, World Economic Outlook, October 2009, figure 1.16

Monthly crude steel production, million tons

Source: World Steel Association

Why do metal prices vary so much?

• Minerals demand is inelastic because – this demand is derived from the demand for the final product and the

minerals generally account for only a small part of the total cost of production– in the short run at least, substitutability between raw materials and other

inputs is relatively restricted• Supply is inelastic because

– the availability of good mineral deposits is fixed– investment in exploring for and developing mineral deposits is costly and

takes time– it takes time to change production rates and once capacity ceilings are

reached, increases in supply require considerable time • While minerals and metals can be stored, with stock variations serving to

offset fluctuations in production or use, stocks are always finite. When they are run down, as they were for many metals from 2000 to 2008, the combination of inelastic supply and inelastic demand can result in dramatic price increases.

Metal prices and stocks, 2002-2008

Source. IMF, World Economic Outlook, October 2008, figure 3.19

Did speculation play a role?No, because...

• The argument is that index funds in particular overwhelmed the market. However,

• The econometric and statistic evidence points to prices having been driven up by industry buyers

• Prices of commodities that are not traded on futures markets, such as iron ore, rose as much as, or more than, those of commodities that are traded on such markets

• Prices of nonferrous metals peaked at very different times during the general upturn

Price risk management (1)

• Instruments for managing commodity price risks include marketing strategies involving:

• the timing of sales and purchases, • long-term contracts with fixed prices, • forward contracts, the use of futures or

options to hedge prices through commodity exchanges and over-the-counter (OTC) markets, and

• the use of swaps and commodity bonds.

Price risk management (2) Forward contracts Futures contracts

Most are traded OTC (Over The Counter, refers to a financial product which is bought directly from a bank or other financial institution and that is not traded on an exchange).

Are traded on organized exchanges through clearing houses

Can be tailor-made to match specific hedging needs

Have standardized contract terms

Require cash transfer only at maturity of contract

Require initial transfer for margin payments and may require daily settlements to adjust margins to adverse price movements

Involve a high degree of counterparty risk because no clearing house facility exists

Imply very little counterparty risk because the clearing house guarantees the fulfilment of contractual obligations

Contain the expectation of physical delivery

Only a small fraction of futures contracts result in actual delivery of the underlying commodity

Price risk management (3) • A commodity exchange or market is a financial market

(exchange floors or electronic networks) where different groups of participants trade commodity contracts with the objective of transferring exposure to commodity price risks.

• The purpose of a futures contract is to provide a hedge against price changes. Since the terms of a futures contract are standardized, the contract may be resold many times. This creates the futures market, where a number of futures contracts with different delivery dates are commonly traded for any particular commodity at any given moment of time.

Price risk management (4)Backwardation and contango

Minerals and the international trading system (1): Tariffs

• Tariffs on mineral commodities are generally low, although they tend to rise with the degree of processing.

• Even a relatively low tariff on processed metal products may provide protection for the domestic industry, since raw materials often account for a major portion of the cost of the metal product (although not of the price of the finished good)

Average applied tariffs for iron and steel (HS 72) and articles of iron and steel (HS 73), average of tariff lines, %

Minerals and the international trading system (2): Non-tariff measures

• Non-tariff measures have been relatively unimportant for minerals and metals, but...

• EU: REACH (Registration, Evaluation, Authorisation and Restriction of Chemical substances): chemical products (including minerals) have to be tested for toxicity.

• the 1992 Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal, limited the participation of developing countries in international trade in scrap since the Convention forbids exports of scrap from developed countries to developing ones.

Minerals and the international trading system (3): restricting or pushing exports

Restrictions on exports• Measures to restrict exports of raw

materials may introduce a wedge between domestic and international prices and offer unfair advantage to domestic processors.

• In June 2009, the EU and the United States both filed requests for consultations with China. In August, they were joined by Mexico.

• According to the requests, China imposes quantitative restrictions on the export of bauxite, coke, fluorspar, silicon carbide, and zinc, and it also imposes export duties on bauxite, coke, fluorspar, magnesium, manganese, silicon metal, yellow phosphorus, and zinc.

WTO anti dumping cases concerning iron and steel, 2000-2009

Source: www.wto.org