PHYSICAL COMMODITY CONTRACTS: HARD LESSONS FOR SOFTS MARKETS?


Commodity derivative markets have a lot in common across the agricultural, energy, and metals spaces.


All these markets use similar derivative instruments and may sometimes face the challenges of backwardation curves, tight stocks,  markets.


 


Of the three sectors, metals can make a case for being the most mature market. In London, metals trading started with the opening of the Royal Exchange in 1571, with metals traders spilling out into the  Exchange (LME) in 1877.


The LME’s unique date system plays a part in its industrial appeal,  precisely matching their underlying physical exposure.


 Physical metals traders will be familiar with a number of clauses, allowing merchants, smelters or processors the ability to manage the timing of shipments or to store and blend materials whilst tailoring their hedge strategy accordingly.


Traders and processors don’t face outright price exposure, instead  premium terms.


These terms appeal to some buyers and sellers in the metals markets.  to softer markets?


We’ll take a look at some common clauses in metals, which may have application in other markets. To begin, it’s useful to know a few things about standard metals contracts:


• Most physical metals and concentrates contracts are priced basis the month’s average of the daily LME Settlement Price. The Settlement is the “Cash” price (i.e. 2 days forward), comparable to “Spot” in FX.


• The month of pricing is called the Quotation Period (“QP”), and a standard contract would specify the quality, the tonnage per QP, the strip of QPs, and the physical premium to the LME price. The QP could be expressed relative to a month of shipment (“M”), or month of arrival (“MA”), i.e. for a month of Shipment M = Feb 2019, a QP of M+2 would be April 2019.


• Metals concentrates (“concs”) are produced from ore, and typically contain approximately 30% of the desired metal mixed with undesirable contents (e.g. sulphur, iron) and perhaps some tiny amounts of precious metals. These are traded basis the same LME price, per Mt of metal contained, minus adjustments for quality and costs of processing 


16 | ADMISI - The Ghost In The Machine | January/February 2019


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