BASE METAL ETCS
Base Metal ETCs Not All Created Equal Physically backed ETCs mean that physical funds will compete
directly with end-users for base metals such as copper and aluminium. Investment in physical ETCs will represent a form of hoarding and directly affect the physical supply-demand balance. The more metal that is owned by investors the less will be available to end users. This is why physically backed ETCs are so attractive to their
biggest supporters. They provide an alternative source of demand for metals such as aluminium that have been in structural over- supply in recent years. Pressure to launch physical ETCs has been most intense from aluminium smelters and merchants; it provides a way to place the huge overhang of surplus inventory accumulated over the past two years with a retail investor base. At present, stocks are financed by investors through commodity
indices and hedge funds via the contango in futures prices. With ETCs the costs of finance and storage will be borne directly by a wider range of retail and institutional investors through the up- front costs of buying units and in ongoing warehousing charges. Physical ETCs have the merit of considerably widening the marketing base. But as promoters of futures-based products and commodity
indices pointed out in the past, physical investment is very much a second-best alternative to investing via futures markets: (1) Investors in a physical fund will not have to pay contango to maintain a long position. But nor will they benefit from any backwardations. (2) Futures investors pay for warehousing via the contango. Investors in a physically backed fund will have to pay fees directly, and cannot hope to have them offset by a scarcity premium during a backwardation. (3) Physical funds provide less opportunity to benefit from the gearing inherent in futures contracts. Investors in futures can earn returns on the whole of their notional investment in the commodity futures – plus a collateral return on the 90 percent or so of the funds that do not have to be put up as initial and variation margin, which can be invested in interest-earning assets such as Treasury securities. In contrast, investors in a physical ETC pay the full face value of their investment up front and will not earn collateral yield. (4) Much of the case for investing in broad-based commodity indices has been based on the claim that investors can capture a “risk premium” built into futures prices -- paid by producers to transfer price risks to investors. Participants in physical funds will not be able to reap this
premium, if it still exists. Instead they will be dependent on timing the market right to capture spot price appreciation. From an investor perspective, physically backed ETCs have all the drawbacks of futures and none of the benefits. Not all base metal ETCs are created equal. Physical ETCs based
on copper, nickel and tin are likely to perform better than ETCs based on aluminium and zinc, because of their higher value-to- volume ratios. In contrast, aluminium, zinc and lead are bulky products that take up lots of room and are expensive to store on a per-tonne and per-dollar basis. ETCs based on these metals are likely to behave more like oil and wheat, where storage charges have driven a big wedge between the appreciation in spot prices and the actual return achieved by investors. John Kemp, Reuters market analyst.
76 December 2010
intends that only “baskets” are tradable. JP Morgan filed with the SEC an application for a
physically backed ETF which, if fully taken up, would result in a holding of 61,800 tonnes of metal stored in the bank’s Henry Bath warehouses. JP Morgan’s ownership of Henry Bath warehouses was viewed as a key element in the launch of its fund as the cost for storing copper would be low. BlackRock claimed in the filing for its fund that it
will be “relatively cost efficient. Because the expenses involved in an investment in physical copper are dispersed among all holders of shares, an investment in shares may represent a cost-efficient alternative to investments in copper for investors not otherwise in a position to participate directly in the market for physical copper,” the filing said. ETF Securities has now launched ETCs for physical copper, nickel and tin – with aluminium, lead, and zinc (and a basket comprising all the metals) available in the new year.
A New Form of Demand Investment going into copper ETCs will be another
form of demand for physical metal. Generally speaking, the effect of fund investment in base metals shows that the price level rises above that which would be expected in the absence of the investment flows and that the new investment also lifts the level of physical stocks that the market has to live with. So all things being equal, the floor price for physical copper is likely to rise as a result of this new investment demand. The ETC holdings may prove to be ‘sticky’ ones and not as volatile as the normal commercial flow of stocks into or out of LME warehouses. On the other hand, ETC holders may prove to be very active traders. Much depends on dealing costs and the overall level of volatility, which I expect to rise quite sharply next year as more ETC money goes into the market.
Conclusion We are in for much more choppy trading in base
metals, and copper in particular, over coming months. Physically backed ETCs should guarantee more volatility ... but so will the gyrations of the dollar and how effective QE2 proves to be. Meanwhile, copper buying behemoth China is holding back from the market for as long as it can. They generally think prices are too high at these levels. They would love to be buyers at US$8,000 per tonne and lower if they get the chance. •
Ted Arnold E:
tedarnold@ukonline.co.uk
Bloomsbury Minerals Economics’ Copper Briefing Service monthly Copper Briefing and rather superb new Quarterly Report on Copper accommodate ETF physical holdings in their analysis, with forecast tonnages out to end-2011 and end-2015.
www.bloomsburyminerals.com
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73 |
Page 74 |
Page 75 |
Page 76 |
Page 77 |
Page 78 |
Page 79 |
Page 80 |
Page 81 |
Page 82 |
Page 83 |
Page 84 |
Page 85 |
Page 86 |
Page 87 |
Page 88 |
Page 89 |
Page 90 |
Page 91 |
Page 92 |
Page 93 |
Page 94 |
Page 95 |
Page 96