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Hedging, pricing & fundamental analysis Presented by Catherine Markey Head of Education and Marketing 4
Hedging, pricing & fundamental analysis
Presented by Catherine Markey
Head of Education and Marketing
4 December 2012, Hong Kong

Course Content

Introduction to hedging – why do companies hedge?

Case study 1: a metal producer hedge with futures

Case study 2: a car manufacturer hedge with LMEswaps

Case study 3: a drinks company hedge with futures

Case study 4: a zinc smelter hedge with options

Fundamental analysis of metal prices – what drives prices and why is the price important?

Emerging economies

2

2
2

What is risk?

What is risk? 3

3

What is risk? 3
What is risk? 3

What is risk?

RISK = (PROBABILITY OF AN EVENT OCCURING) X (IMPACT OF EVENT OCCURING)

4

What is risk? RISK = (PROBABILITY OF AN EVENT OCCURING) X (IMPACT OF EVENT OCCURING) 4
What is risk? RISK = (PROBABILITY OF AN EVENT OCCURING) X (IMPACT OF EVENT OCCURING) 4

Risk management

Risks: Identify, assess, prioritise
Risks: Identify, assess, prioritise

Apply resources to:

Risks: Identify, assess, prioritise Apply resources to: Minimise, monitor, control events that may impact: •
Minimise, monitor, control events that may impact: • Price • Maximise opportunities
Minimise, monitor, control
events that may impact:
• Price
• Maximise opportunities

5

Apply resources to: Minimise, monitor, control events that may impact: • Price • Maximise opportunities 5
Apply resources to: Minimise, monitor, control events that may impact: • Price • Maximise opportunities 5

When did you price your LME Copper?

LME Copper cash sellers price January 2008– July 2012

6

12000

10000

8000

6000

4000

2000

0

LME Copper cash price

6 12000 10000 8000 6000 4000 2000 0 LME Copper cash price 2008 2009 2010 2011

2008

2009

2010

2011

2012

 

Date

Source: Thomson Reuters Datastream

4000 2000 0 LME Copper cash price 2008 2009 2010 2011 2012   Date Source: Thomson
4000 2000 0 LME Copper cash price 2008 2009 2010 2011 2012   Date Source: Thomson

When did you price your LME Nickel?

LME Nickel cash sellers price January 2006 – July 2012

LME Nickel cash price

60000 50000 40000 30000 20000 10000 0
60000
50000
40000
30000
20000
10000
0

2006

2007

2008

2009

2010

2011

2012

 

Date

7

Source: Thomson Reuters Datastream

20000 10000 0 2006 2007 2008 2009 2010 2011 2012   Date 7 Source: Thomson Reuters
20000 10000 0 2006 2007 2008 2009 2010 2011 2012   Date 7 Source: Thomson Reuters

Origins of commodity price volatility

Production

steps

Origins of commodity price volatility Production steps Consumer Demand Volatility is inherent in commodity markets. Stems
Origins of commodity price volatility Production steps Consumer Demand Volatility is inherent in commodity markets. Stems

Consumer Demand

Volatility is inherent in commodity markets.

Stems from lack of responsiveness of both demand and supply in short term

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Volatility is inherent in commodity markets. Stems from lack of responsiveness of both demand and supply
Volatility is inherent in commodity markets. Stems from lack of responsiveness of both demand and supply

Volatility is inherent in commodity markets

Inflexibility of supply:

• Economies of scale

• High fixed costs

• Development lead times

Inflexibility of demand:

• Lack of substitutes

• Sensitive to business cycle

Large price swings needed to force capacity offline during a surplus, and bring it back online during a shortage

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cycle Large price swings needed to force capacity offline during a surplus, and bring it back
cycle Large price swings needed to force capacity offline during a surplus, and bring it back

What is hedging?

Hedging

Establishing a position in a commodity futures market (LME) which is equal and opposite to a risk on a physical market.

• Protects against adverse price movements

• Locks in an agreed profit margin

• Protects inventory value

10

market. • Protects against adverse price movements • Locks in an agreed profit margin • Protects
market. • Protects against adverse price movements • Locks in an agreed profit margin • Protects

The metals value chain

How to use an LME price

Mining

LME price

LME price

LME price

minus

minus

discount

discount

LME price plus production costs and profit margin

Concentration
Concentration

Low Metal

Content

Semi Smelting Metal Products Fabricated Products Cathode Billet Wire Rebar Ingot
Semi
Smelting
Metal Products
Fabricated
Products
Cathode
Billet
Wire
Rebar
Ingot
Cans
Cans
Low Metal Content Semi Smelting Metal Products Fabricated Products Cathode Billet Wire Rebar Ingot Cans 11
Low Metal Content Semi Smelting Metal Products Fabricated Products Cathode Billet Wire Rebar Ingot Cans 11
Low Metal Content Semi Smelting Metal Products Fabricated Products Cathode Billet Wire Rebar Ingot Cans 11

11

Low Metal Content Semi Smelting Metal Products Fabricated Products Cathode Billet Wire Rebar Ingot Cans 11
Low Metal Content Semi Smelting Metal Products Fabricated Products Cathode Billet Wire Rebar Ingot Cans 11

Exercise – you tell me!

Producer

Producer Short   Buy Sell

Short

 
Buy Sell
Buy
Sell

Consumer

Long Short
Long
Short
 
Buy Sell
Buy
Sell

12

Exercise – you tell me! Producer Short   Buy Sell Consumer Long Short  
Exercise – you tell me! Producer Short   Buy Sell Consumer Long Short  

Hedger vs speculator

A hedger starts with a price exposure, buys or sells futures contracts, and therefore offsets the price exposure.

A speculator starts without price exposure, buys or sells futures contracts, and takes on price exposure

13

• A speculator starts without price exposure, buys or sells futures contracts, and takes on price
• A speculator starts without price exposure, buys or sells futures contracts, and takes on price

Short hedge

Short hedge 14

14

Short hedge

• Used to protect inventory value or sale at an unknown price

• A decline in prices generates profits in the futures market, which are offset by depreciation in the value of the physical inventory

• The opposite happens when prices rise

15

which are offset by depreciation in the value of the physical inventory • The opposite happens
which are offset by depreciation in the value of the physical inventory • The opposite happens

Short hedge – rising price

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Contracted price

Short futures position

Long physical position

Profit Loss
Profit
Loss

-

+ Market price

Contracted price Market price
Contracted price
Market price
price Short futures position Long physical position Profit Loss - + Market price Contracted price Market
price Short futures position Long physical position Profit Loss - + Market price Contracted price Market

Short hedge – falling price

Short futures position

Contracted price

Long physical position

Profit Loss
Profit
Loss

-

+ Market price

Contracted price Market price
Contracted price
Market price

17

futures position Contracted price Long physical position Profit Loss - + Market price Contracted price Market
futures position Contracted price Long physical position Profit Loss - + Market price Contracted price Market

Strategic short hedge

Strategic short hedge 18

18

Case study 1: a nickel producer

Case study 1: a nickel producer 19

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Strategic short hedge example

Strategic hedge taking advantage of favourable prices

Producers can sell forward production and lock in known price when prices are historically high e.g. nickel 2007

Consumers can lock in raw material costs when prices are historically low e.g. copper early 2009

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e.g. nickel 2007 • Consumers can lock in raw material costs when prices are historically low
e.g. nickel 2007 • Consumers can lock in raw material costs when prices are historically low

Strategic short hedge example

ABC nickel producer Ltd

Strategic short hedge example ABC nickel producer Ltd 21

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Strategic short hedge example ABC nickel producer Ltd 21
Strategic short hedge example ABC nickel producer Ltd 21

Strategic short hedge example

ABC nickel producer Ltd

It is 7 th May 2007 and the producer receives a purchase order for metal to be delivered in fifteen months

Quantity Delivery date Sales pricing basis

600 tonnes 7 th Aug 2008 Unknown LME settlement price (day of delivery) $42,100– 42,150 per tonne Aims and Action?

Current (known) 7 th August price ABC’s risk?

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of delivery) $42,100– 42,150 per tonne Aims and Action? Current (known) 7 t h August price
of delivery) $42,100– 42,150 per tonne Aims and Action? Current (known) 7 t h August price

Strategic short hedge example

 

LME

Physical

7 th May 2007

Produce metal = long physical

Sell 100 lots LME Nickel futures prompt 7 th Aug 2008 @ $42,100mt

Sell 600mt Ni @ Unknown Sett priced basis and delivery in 15 months (7 th Aug

2008)

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Aug 2008 @ $42,100mt Sell 600mt Ni @ Unknown Sett priced basis and delivery in 15
Aug 2008 @ $42,100mt Sell 600mt Ni @ Unknown Sett priced basis and delivery in 15

Price fix hedge example

ABC nickel producer Ltd

5 th August 2008 – Scenario 1 (falling market price)

LME settlement price

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$18,730 per tonne

nickel producer Ltd 5 t h August 2008 – Scenario 1 (falling market price) LME settlement
nickel producer Ltd 5 t h August 2008 – Scenario 1 (falling market price) LME settlement

Price fix hedge example

 

LME

 

Physical

7 th May 2007

Produce Metal = Long Physical

 

Sell 100 lots LME Nickel futures prompt 7 th Aug 2008 @ $42,100mt

 

5 th Aug 2008

Buy back 100 lots Close 2 nd Ring Cash LME Nickel @ $18,730mt

 

7 th Aug 2008

7 th Aug 2008

LME contracts settle Realized LME profit =

 

Sell 600mt Nickel to converter @

 

$23,370mt

$18,730mt

 

Total revenue from sale =

 

$18,730 + $23,370 =

$42,100mt

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@   $23,370mt $18,730mt   Total revenue from sale =   $18,730 + $23,370 = $42,100mt
@   $23,370mt $18,730mt   Total revenue from sale =   $18,730 + $23,370 = $42,100mt

Long hedge

Long hedge 26

26

Long hedge

Purchase of futures contracts by a firm worried about rising prices

• Used to protect against price increases in the future

• Offers the chance to lock in profits (if income from operations can be maintained)

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price increases in the future • Offers the chance to lock in profits (if income from
price increases in the future • Offers the chance to lock in profits (if income from

Long hedge – rising price

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Contracted price

Short physical position

Long futures position

Profit Loss
Profit
Loss

-

+ Market price

Contracted price Market price
Contracted price
Market price
p r i c e Short physical position Long futures position Profit Loss - + Market
p r i c e Short physical position Long futures position Profit Loss - + Market

Long hedge - falling price

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Contracted price

Short physical position

Long futures position

Profit Loss
Profit
Loss

-

+ Market price

Contracted price Market price
Contracted price
Market price
p r i c e Short physical position Long futures position Profit Loss - + Market
p r i c e Short physical position Long futures position Profit Loss - + Market

Hedging with LMEswaps

Hedging with LMEswaps 30

30

Average Pricing

LME Aluminium settlement price Nov 2010

Average Pricing LME Aluminium settlement price Nov 2010 November average $2333.07 31

November average

$2333.07

31

Average Pricing LME Aluminium settlement price Nov 2010 November average $2333.07 31
Average Pricing LME Aluminium settlement price Nov 2010 November average $2333.07 31

Hedging with LMEswaps

Typical pricing formula:

M–1

(pricing month before month of shipment)

M

(pricing month of shipment)

M+1

(pricing month after month of shipment)

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month before month of shipment) M (pricing month of shipment) M+1 (pricing month after month of
month before month of shipment) M (pricing month of shipment) M+1 (pricing month after month of

LMEswaps

• Financially settled two-part futures contract

• Buy/sell fixed price for floating price

33

LMEswaps • Financially settled two-part futures contract • Buy/sell fixed price for floating price 33
LMEswaps • Financially settled two-part futures contract • Buy/sell fixed price for floating price 33

LMEswaps

• Buyer of LMEswap fixes the purchase price and closes this purchase at the MASP. Cash difference is paid the second business day of the next month

• Seller fixes the sale price and closes this sale at the MASP. Cash difference is paid the second business day of the next month

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the sale price and closes this sale at the MASP. Cash difference is paid the second
the sale price and closes this sale at the MASP. Cash difference is paid the second

Case study 2: a car manufacturer hedge with LMEswaps

35

35
35

Average price hedging

Scenario – BAT automobile company

November

An automobile manufacturer has published the sales price for a car. It has not been able to negotiate a fixed price for that period for the monthly purchases of aluminium alloy parts for that car; the contract will be priced on the unknown January MASP (monthly average settlement price).

BAT’s budget is based on the current market price of LME Aluminium Alloy and it needs to ensure that the volatile price of raw material does not impact on its profit and loss for the period.

What action does the company have to take?

Quantity Period Current Jan price

36

300 tonnes of LME Aluminium Alloy (AA) January $2010 per tonne

have to take? Quantity Period Current Jan price 36 300 tonnes of LME Aluminium Alloy (AA)
have to take? Quantity Period Current Jan price 36 300 tonnes of LME Aluminium Alloy (AA)

Hedge using LMEswaps

• Aluminium alloy (AA) LMEswap quote for January is $2000 - $2010 per tonne

• BAT agrees to buy at the fixed price of $2010 per tonne and settle this financially at the Monthly Average Settlement Price (MASP) on the last business day of January

• If the price settles higher than $2010, BAT receives the difference. If the price settles lower than $2010 BAT pays the difference.

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settles higher than $2010, BAT receives the difference. If the price settles lower than $2010 BAT
settles higher than $2010, BAT receives the difference. If the price settles lower than $2010 BAT

Car manufacturer

BAT automobile co.

LME

Physical

Nov

 

Buy 10 lots January AA LMEswap @

$2010mt

31 Jan

31 Jan

Buy 250mt March AA requirement basis

Settlement for difference between fixed price $2010mt and floating MASP

 

$2100mt

$2100mt

 

2 Feb

Total purchase price = $2100 - $90 =

$2,010mt

Receive cash settlement

$90mt

 

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  2 Feb Total purchase price = $2100 - $90 = $2,010mt Receive cash settlement $90mt
  2 Feb Total purchase price = $2100 - $90 = $2,010mt Receive cash settlement $90mt
  2 Feb Total purchase price = $2100 - $90 = $2,010mt Receive cash settlement $90mt

Case study 3: a drinks company hedge with futures

Case study 3: a drinks company hedge with futures 39

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Case study 3: a drinks company

February

• It is February. A consumer of aluminium cans has agreed to buy material with an aluminium coil content of 250mt basis LME settlement price for 18 November. The consumer wishes to eliminate risk from any movement in price. The current 18 Nov forward price is:

Current LME prices

LME Aluminium

18

November Buyer

2215

18

November Seller

2225

If the price of the cans rises, they cannot pass any increase on.

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Buyer 2215 18 November Seller 2225 If the price of the cans rises, they cannot pass
Buyer 2215 18 November Seller 2225 If the price of the cans rises, they cannot pass

Drinks company

Answer

Drinks company Answer LME Physical Feb Buy 10 lots (250 tonnes) Al 18 Nov @ $2225mt

LME

Physical

Drinks company Answer LME Physical Feb Buy 10 lots (250 tonnes) Al 18 Nov @ $2225mt

Feb Buy 10 lots (250 tonnes) Al 18 Nov @

$2225mt

41

Drinks company Answer LME Physical Feb Buy 10 lots (250 tonnes) Al 18 Nov @ $2225mt
Drinks company Answer LME Physical Feb Buy 10 lots (250 tonnes) Al 18 Nov @ $2225mt

Drinks company

Answer

16 November LME settlement price

42

Aluminium

November

Buyer

3,300

November

Seller

3,310

Drinks company Answer 16 November LME settlement price 42 Aluminium November Buyer 3,300 November Seller 3,310
Drinks company Answer 16 November LME settlement price 42 Aluminium November Buyer 3,300 November Seller 3,310

Drinks company

Answer

LME

Physical

Feb Buy 10 lots (250 tonnes) Al 18 Nov @

 
 

$2,225mt

16 Nov Sell 10 lots Al Cash at

$3,310mt

16 Nov Buy 250mt material basis LME Al

 

Settlement price of

$3,310mt

Nominal LME profit =

$1,085mt

Total buy price = $3,310- $1,085 =

$2,225mt

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Settlement price of $3,310mt Nominal LME profit = $1,085mt Total buy price = $3,310- $1,085 =
Settlement price of $3,310mt Nominal LME profit = $1,085mt Total buy price = $3,310- $1,085 =
Settlement price of $3,310mt Nominal LME profit = $1,085mt Total buy price = $3,310- $1,085 =

Drinks company

Answer

16 November LME settlement price

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Aluminium

November

Buyer

1,300

November

Seller

1,310

Drinks company Answer 16 November LME settlement price 44 Aluminium November Buyer 1,300 November Seller 1,310
Drinks company Answer 16 November LME settlement price 44 Aluminium November Buyer 1,300 November Seller 1,310

Drinks company

Answer

LME

Physical

Feb Buy 10 lots (250 tonnes) Al 18 Nov @

 
 

$2,225mt

16 Nov Sell 10 lots Al Cash at

$1,310mt

16 Nov Buy 250mt material basis LME Al

 

Settlement price of

$1,310mt

Nominal LME loss =

$915mt

Total buy price = $1,310 + $915 =

$2,225mt

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Settlement price of $1,310mt Nominal LME loss = $915mt Total buy price = $1,310 + $915
Settlement price of $1,310mt Nominal LME loss = $915mt Total buy price = $1,310 + $915
Settlement price of $1,310mt Nominal LME loss = $915mt Total buy price = $1,310 + $915

Case study 4: a zinc smelter hedge with options

Case study 4: a zinc smelter hedge with options 46

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Case study 4: a smelter hedge using options

December 2012

• The forward price for zinc is $1800 for 2013. A zinc smelter has agreed to sell zinc at the unknown LME price for 2013

• Prices are low but the smelter does not want to risk selling at an even lower price

• Buying a put is one solution

Current 2013 put prices

LME Zinc

Strike 1800

120

Strike 1750

95

47

• Buying a put is one solution Current 2013 put prices LME Zinc Strike 1800 120
• Buying a put is one solution Current 2013 put prices LME Zinc Strike 1800 120

Selling an option

Another major reason for selling options, is to reduce the cost of buying other options, assuming that this option purchase is the primary hedge objective

The MinMax

Maybe suitable for both hedge buyers and sellers

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that this option purchase is the primary hedge objective The MinMax Maybe suitable for both hedge
that this option purchase is the primary hedge objective The MinMax Maybe suitable for both hedge

The MinMax strategy (risk reversal, collar, fence)

The consumer MinMax

Buys calls and sells puts Setting a maximum price that can be paid but limiting any downside participation

The producer MinMax

Buys puts and sells calls Setting a minimum hedge sale price but limiting any upside price participation

49

MinMax Buys puts and sells calls Setting a minimum hedge sale price but limiting any upside
MinMax Buys puts and sells calls Setting a minimum hedge sale price but limiting any upside

Producer MinMax

Producer MinMax 50 The MAX. Producer sells out- of-the-money call at $1900 They will sell at

50

The MAX. Producer sells out- of-the-money call at $1900

They will sell at market within this band

The MIN. Producer buys out- of-the-money puts at $1700

call at $1900 They will sell at market within this band The MIN. Producer buys out-
call at $1900 They will sell at market within this band The MIN. Producer buys out-

MinMax

Variations and variables

Zero-cost is the norm but not essential

Ratio does not have to be 1 : 1

Return for zinc smelter is no lower than $1700 and no higher than $1900

51

not essential Ratio does not have to be 1 : 1 Return for zinc smelter is
not essential Ratio does not have to be 1 : 1 Return for zinc smelter is

Fundamental analysis of the industrial metals

Fundamental analysis of the industrial metals 52

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Introduction

Define a metal

– How are they made?

– Where are they from?

– Where are they used?

– Why is the price important?

53

Define a metal – How are they made? – Where are they from? – Where are
Define a metal – How are they made? – Where are they from? – Where are
Define a metal – How are they made? – Where are they from? – Where are
Define a metal – How are they made? – Where are they from? – Where are

Metals reserve map

Metals reserve map Chile exports copper ores/metal to China Zambian copper ore shipped to China and

Chile exports copper ores/metal to China

Zambian copper ore shipped to China and refined metal to Europe.

Australia exports ores to China for further processing

A key trading route is Russia – EU allowing Europe to easily consume Russian metals

Canada exports large quantities of materials to US both ores and semi- finished.

FeCu Ni Al Zn

CuFe Ni Al Zn

NiFe Cu Al Zn

AlFe Cu Ni Zn

ZnFe Cu Ni Al

SnCanada exports large quantities of materials to US both ores and semi- finished. Fe Cu Ni

PbCanada exports large quantities of materials to US both ores and semi- finished. Fe Cu Ni

54

Canada exports large quantities of materials to US both ores and semi- finished. Fe Cu Ni
Canada exports large quantities of materials to US both ores and semi- finished. Fe Cu Ni

PEST analysis

PEST - Political, Economic, Social & Technological factors of the macro- environment.

POLITICAL ANALYSIS

ECONOMIC ANALYSIS

Trade restrictions and tariffs (arbitrage).

Economic growth rate

Political stability (Middle East, Nigeria)

Exchange rates, Inflation rate, Interest rates etc

Anti-trust laws

Business cycle stage (prosperity, recession, recovery)

Environmental regulations

Employment laws (cheap labour)

Labour costs

Tax policy

Government intervention in the free market

SOCIAL ANALYSIS

TECHNOLOGICAL ANALYSIS

Demographics

Research & Development Activity

Population growth rate

Rate of technological change

Class structure

Impact of technology on products

Education

Impact on cost structure

Emphasis on environment, safety & health.

Impact on value chain structure

55

Impact on cost structure  Emphasis on environment, safety & health.  Impact on value chain
Impact on cost structure  Emphasis on environment, safety & health.  Impact on value chain

Aluminium industry overview

• Export restrictions and tariffs • Resources/ technology
• Export restrictions and tariffs
• Resources/ technology

Bauxite/ alumina Freight of raw materials Electricity

Bauxite/ alumina Freight of raw materials Electricity Economic growth (GDP) Industrial production (IP) • Key

Economic growth (GDP) Industrial production (IP)

• Key driver for consumption growth

production (IP) • Key driver for consumption growth 56 • Refinery expensive to start and run

56

• Refinery expensive to start and run

• Distribution of producers energy intensive

run • Distribution of producers • energy intensive Refined Aluminium (ingots) Aluminium products Eg. Sheet,

Refined Aluminium (ingots)

producers • energy intensive Refined Aluminium (ingots) Aluminium products Eg. Sheet, cable, foil Transport

Aluminium products Eg. Sheet, cable, foil

Transport

Construction

Packaging

Eg. Sheet, cable, foil Transport Construction Packaging • Environmental regulation/ emissions • Substitutes
• Environmental regulation/ emissions • Substitutes e.g. plastics in transport/ packaging and copper cables
• Environmental regulation/
emissions
• Substitutes e.g. plastics in
transport/ packaging and
copper cables
• Environmental regulation/ emissions • Substitutes e.g. plastics in transport/ packaging and copper cables
• Environmental regulation/ emissions • Substitutes e.g. plastics in transport/ packaging and copper cables

Collating raw data

Key Economic Data

– GDP/IP including sector IPs (construction, engineering, auto, transport)

– Government & private sector spending e.g. fixed asset investment

– Purchasing Managers Index (PMI)

– Unemployment & household disposable incomes

– Inflation rates, interest rates and exchange rates

– Other e.g. money supply, fiscal policy, economic stimulus packages

57

rates, interest rates and exchange rates – Other e.g. money supply, fiscal policy, economic stimulus packages
rates, interest rates and exchange rates – Other e.g. money supply, fiscal policy, economic stimulus packages
Historical copper prices trend Real Copper price (2012 USD) $15,000 $12,000 Aug 12 $9,000 $6,000
Historical copper prices trend
Real Copper price (2012 USD)
$15,000
$12,000
Aug 12
$9,000
$6,000
$3,000
33 yrs
40 yrs
29 yrs
10 yrs
4.6% pa
3.1% pa
-4.8% pa
14.2%
$0
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010

58

4.6% pa 3.1% pa -4.8% pa 14.2% $0 1900 1910 1920 1930 1940 1950 1960 1970

USGS, LME

4.6% pa 3.1% pa -4.8% pa 14.2% $0 1900 1910 1920 1930 1940 1950 1960 1970

Demand Forecasting

Demand Forecasting 59

59

Market modelling - forecasting

• Econometrics and quantitative techniques such as correlations and regressions

• Analyst’s gut instinct & knowledge of industry trends through experience and new information assimilated may lead to different forecasts

• Analyst will also consider current market forces at play in Porter’s Analysis and/or relevant ‘PEST’ issues.

• A forecast is not a mere prediction!

60

forces at play in Porter’s Analysis and/or relevant ‘PEST’ issues. • A forecast is not a
forces at play in Porter’s Analysis and/or relevant ‘PEST’ issues. • A forecast is not a

Top down approach - macroeconomics

Effect of IP/GDP growth on demand

Consumption by end use sector

– Vehicle production

– Housing

Effect of inventory changes

61

growth on demand • Consumption by end use sector – Vehicle production – Housing • Effect
growth on demand • Consumption by end use sector – Vehicle production – Housing • Effect

US, Europe and China GDP

2012 forecasts:

China 8.1% growth, US 2.1% growth, EU 0.5% decline

Y-o-Y percentage change in quarterly GDP 15 15 10 10 7.7 5 5 2.32 0
Y-o-Y percentage change in quarterly GDP
15
15
10
10
7.7
5
5
2.32
0
0
-0.47
-5
-5
-10
-10
96
98
00
02
04
06
08
10
12
US
China
Europe
Source: Thomson Reuters Datastream

62

Q2 2012 Chinese GDP growth slowing

US growth stable

EU heading for recession?

Source: National Sources, The Economist

62 Q2 2012 Chinese GDP growth slowing US growth stable EU heading for recession? Source: National
62 Q2 2012 Chinese GDP growth slowing US growth stable EU heading for recession? Source: National

Metals end-use consumption by sector

Copper Copper 5% 10% 31% 12% 17% 25%
Copper
Copper
5%
10%
31%
12%
17%
25%
by sector Copper Copper 5% 10% 31% 12% 17% 25% 63 Electrical/Electronic Construction Consumer & General

63

by sector Copper Copper 5% 10% 31% 12% 17% 25% 63 Electrical/Electronic Construction Consumer & General

Electrical/Electronicby sector Copper Copper 5% 10% 31% 12% 17% 25% 63 Construction Consumer & General Transport

ConstructionCopper 5% 10% 31% 12% 17% 25% 63 Electrical/Electronic Consumer & General Transport Industrial Machinery Other

Consumer & General31% 12% 17% 25% 63 Electrical/Electronic Construction Transport Industrial Machinery Other 6% 12% Aluminium

Transport63 Electrical/Electronic Construction Consumer & General Industrial Machinery Other 6% 12% Aluminium Aluminium 6%

Industrial MachineryConstruction Consumer & General Transport Other 6% 12% Aluminium Aluminium 6% 10% 24% 25% 17%

OtherConsumer & General Transport Industrial Machinery 6% 12% Aluminium Aluminium 6% 10% 24% 25% 17% Transport

6%

12%

Aluminium

Aluminium

6% 10% 24% 25%
6%
10%
24%
25%

17%

TransportOther 6% 12% Aluminium Aluminium 6% 10% 24% 25% 17% Construction Packaging Electrical Consumer durables

Construction6% 12% Aluminium Aluminium 6% 10% 24% 25% 17% Transport Packaging Electrical Consumer durables Machinery &

PackagingAluminium 6% 10% 24% 25% 17% Transport Construction Electrical Consumer durables Machinery & equipment Other

Electrical6% 10% 24% 25% 17% Transport Construction Packaging Consumer durables Machinery & equipment Other Source: CRU

Consumer durablesAluminium 6% 10% 24% 25% 17% Transport Construction Packaging Electrical Machinery & equipment Other Source: CRU

Machinery & equipmentAluminium Aluminium 6% 10% 24% 25% 17% Transport Construction Packaging Electrical Consumer durables Other Source: CRU

Other6% 10% 24% 25% 17% Transport Construction Packaging Electrical Consumer durables Machinery & equipment Source: CRU

24% 25% 17% Transport Construction Packaging Electrical Consumer durables Machinery & equipment Other Source: CRU
24% 25% 17% Transport Construction Packaging Electrical Consumer durables Machinery & equipment Other Source: CRU
24% 25% 17% Transport Construction Packaging Electrical Consumer durables Machinery & equipment Other Source: CRU

Source: CRU

24% 25% 17% Transport Construction Packaging Electrical Consumer durables Machinery & equipment Other Source: CRU

US auto production & construction

US auto production & construction US recessions highlighted in grey • Vehicle production decreased approximately 50%
US auto production & construction US recessions highlighted in grey • Vehicle production decreased approximately 50%
US auto production & construction US recessions highlighted in grey • Vehicle production decreased approximately 50%

US recessions highlighted in grey

& construction US recessions highlighted in grey • Vehicle production decreased approximately 50% through

• Vehicle production decreased approximately 50% through 2008, but has seen improvement in recent months

• US Housing starts have stabilised through 2009.

Source: Federal Reserve

64

but has seen improvement in recent months • US Housing starts have stabilised through 2009. Source:
but has seen improvement in recent months • US Housing starts have stabilised through 2009. Source:

Demand forecasting – bottom up approach

• Production data for the end-uses of the product will be summed up to find the total demand for the product.

Example 1: Demand for semi-finished product

= Production of finished products/ Product yield

Example 2: Steel plate demand from shipbuilding

= Number of ships X Steel plate used per ship

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Product yield • Example 2: Steel plate demand from shipbuilding = Number of ships X Steel
Product yield • Example 2: Steel plate demand from shipbuilding = Number of ships X Steel

Interpretation of stocks data

Interpretation of stocks data 66

66

Examples: interpretation of stocks data

• LME stocks + LME cancelled stocks

• Other exchanges’ stocks e.g. Shanghai, Comex

• Producer, country, commercial stocks

• Unreported stocks

67

• Other exchanges’ stocks e.g. Shanghai, Comex • Producer, country, commercial stocks • Unreported stocks 67
• Other exchanges’ stocks e.g. Shanghai, Comex • Producer, country, commercial stocks • Unreported stocks 67
Metal copper stocks 2,000 1,800 1,600 LME 1,400 COMEX 1,200 SHFE 1,000 Consumer 800 Merchant
Metal copper stocks
2,000
1,800
1,600
LME
1,400
COMEX
1,200
SHFE
1,000
Consumer
800
Merchant
600
Producer
400
200
-
• Recession band highlighted in grey (US recessions, NBER).
• Demand in recession decreases hence stocks increase.
Source: WBMS
68
Closing Stock (thousand tonnes)
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012

Nickel stocks and price trend

Record Max Date: 16 May 2007 Price: $54,200 Record minimum Date: 5 Feb 2007 Stock:
Record Max
Date: 16 May 2007
Price: $54,200
Record minimum
Date: 5 Feb 2007
Stock: 2,982 tonnes

69

Source: LME

trend Record Max Date: 16 May 2007 Price: $54,200 Record minimum Date: 5 Feb 2007 Stock:
trend Record Max Date: 16 May 2007 Price: $54,200 Record minimum Date: 5 Feb 2007 Stock:

Other prices drivers

• Freight

• Regulation

• Stimulus packages

70

Other prices drivers • Freight • Regulation • Stimulus packages 70
Other prices drivers • Freight • Regulation • Stimulus packages 70

Production forecasting

Production forecasting 71

71

Market modelling – production forecasting

• Following factors must be considered:

– New capacity

– Unplanned stoppages e.g. strikes, breakdowns, raw material shortages, disasters, wars etc

– Supply cutbacks as a result of lacklustre demand

– The cost curve i.e. is the cost of production below the sale price?

– Any capacity closures

• Production forecasts will also be influenced by the implied net trade balance i.e. whether the analyst thinks the country will be a net importer or net exporter.

72

by the implied net trade balance i.e. whether the analyst thinks the country will be a
by the implied net trade balance i.e. whether the analyst thinks the country will be a

Forecasting prices

Forecasting prices 73

73

Market modelling – forecasting prices

So what determines the price?

Simply put, it’s the ability of the market to satisfy demand:

– If demand rises faster than production, prices are likely to increase.

– If production rises faster than demand prices are likely to fall.

– When both demand and production are falling, the one that is falling faster is likely to determine the direction of the prices.

When forecasting prices analysts will follow the changes in supply/demand while considering the cost curve.

Seasonal patterns are also factored into the forecasts.

74

in supply/demand while considering the cost curve. • Seasonal patterns are also factored into the forecasts.
in supply/demand while considering the cost curve. • Seasonal patterns are also factored into the forecasts.

Emerging economies

Emerging economies 75

75

Emerging economies

Overview

• What is an emerging economy / BRICS countries?

• BRICS background

• How can GDP data give us an insight into the past, present and future of developing economies?

• Consumerism and infrastructure

• Case study: Aluminium

76

the past, present and future of developing economies? • Consumerism and infrastructure • Case study: Aluminium
the past, present and future of developing economies? • Consumerism and infrastructure • Case study: Aluminium

Emerging economies

Emerging economies Source: Black Coffee Project 77 BRIC Brazil Russia India China + South Africa =

Source: Black Coffee Project

77

BRIC

Brazil

Russia

India

China

+ South Africa

= BRICS

- developing countries

- large populations/ land mass

- key consumers/ producers

- drivers of commodity prices

BRICS countries are KEY consumers and/or producers of industrial metals

producers - drivers of commodity prices • BRICS countries are KEY consumers and/or producers of industrial
producers - drivers of commodity prices • BRICS countries are KEY consumers and/or producers of industrial

BRICS GDP

BRICS GDP • China has the second largest GDP (PPP) after the US; since 2002 increase
BRICS GDP • China has the second largest GDP (PPP) after the US; since 2002 increase

• China has the second largest GDP (PPP) after the US; since 2002 increase in GDP has been between 10% and 17.4% y-o-y

78

China has the second largest GDP (PPP) after the US; since 2002 increase in GDP has
China has the second largest GDP (PPP) after the US; since 2002 increase in GDP has

BRICS GDP

BRICS GDP 79
BRICS GDP 79

79

BRICS GDP 79
BRICS GDP 79

BRICS GDP – slowing growth in China

- Quarterly change in Chinese GDP

BRICS GDP – slowing growth in China - Quarterly change in Chinese GDP Q2 2012 =
Q2 2012 = 7.6%
Q2 2012
= 7.6%

80

BRICS GDP – slowing growth in China - Quarterly change in Chinese GDP Q2 2012 =
BRICS GDP – slowing growth in China - Quarterly change in Chinese GDP Q2 2012 =

BRICS GDP –Slowing growth overall

- Quarterly change in GDP

- Quarterly change in GDP
- Quarterly change in GDP

81

BRICS GDP –Slowing growth overall - Quarterly change in GDP 81
BRICS GDP –Slowing growth overall - Quarterly change in GDP 81

Consumerism & infrastructure

82

Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand

METALS

Demand

Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand
Consumerism & infrastructure 82 METALS Demand

Consumerism & infrastructure

Chinese car sales

Chinese lead demand nearly double since 2007
Chinese
lead
demand
nearly
double
since 2007

- Don’t forget the e-bikes! - estimates of 120 million in 2010, with 40 million annual production

83

since 2007 - Don’t forget the e-bikes! - estimates of 120 million in 2010, with 40
since 2007 - Don’t forget the e-bikes! - estimates of 120 million in 2010, with 40

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Consumerism & infrastructure

- Chinese high-ways doubled in length in 5 years

 

90,000

80,000

70,000

60,000

50,000

km

 

40,000

30,000

20,000

10,000

0

84

90,000 80,000 70,000 60,000 50,000 km   40,000 30,000 20,000 10,000 0 84
90,000 80,000 70,000 60,000 50,000 km   40,000 30,000 20,000 10,000 0 84
90,000 80,000 70,000 60,000 50,000 km   40,000 30,000 20,000 10,000 0 84

Consumerism & infrastructure

- China and the BRICS can still expand

1,000 Monaco USA Exception 800 Iceland Spain Australia Canada Japan Norway 600 Germany UK France
1,000
Monaco
USA
Exception
800
Iceland
Spain
Australia
Canada
Japan
Norway
600
Germany
UK
France
Sweden
Korea
400
Mexico
Brazil, Russia
200
India, China
0
0
5
10
15
20
25
30
35
40
45
50
Vehicles per 1000 people

Length of road network - km per 1000 people

85

0 0 5 10 15 20 25 30 35 40 45 50 Vehicles per 1000 people
0 0 5 10 15 20 25 30 35 40 45 50 Vehicles per 1000 people

China completely dominates consumption

Regional refined metals consumption growth, 2007-12 ‘000 tonnes Source CRU

Cu
Cu
completely dominates consumption Regional refined metals consumpt ion growth, 2007-12 ‘000 tonnes Source CRU Cu 86

86

Al
Al
completely dominates consumption Regional refined metals consumpt ion growth, 2007-12 ‘000 tonnes Source CRU Cu 86
completely dominates consumption Regional refined metals consumpt ion growth, 2007-12 ‘000 tonnes Source CRU Cu 86
completely dominates consumption Regional refined metals consumpt ion growth, 2007-12 ‘000 tonnes Source CRU Cu 86

and

is expected to continue to do so

Regional refined metals consumption growth, 2012-17 ‘000 tonnes Source:

CRU

Cu
Cu
is expected to continue to do so Regional refined metals consumpt ion growth, 2012-17 ‘000 tonnes

87

Al
Al
is expected to continue to do so Regional refined metals consumpt ion growth, 2012-17 ‘000 tonnes
is expected to continue to do so Regional refined metals consumpt ion growth, 2012-17 ‘000 tonnes
is expected to continue to do so Regional refined metals consumpt ion growth, 2012-17 ‘000 tonnes

~Case study: China and aluminium

88

88
88

Bauxite to aluminium

Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot

Alumina

Bauxite

Ore

Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot

Aluminium chassis

Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot

RUSAL aluminium smelter

Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot

89

Aluminium ingot

Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot
Bauxite to aluminium Alumina Bauxite Ore Aluminium chassis RUSAL aluminium smelter 89 Aluminium ingot

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Aluminium Consumption

-In 2011 BRICS consumptions = ROW consumption

-Chinese consumption = 14% in 2000 41% in 2011
-Chinese consumption =
14% in 2000
41% in 2011
$3,000 25,000 $2,500 20,000 $2,000 15,000 $1,500 10,000 $1,000 5,000 $500 $- 0 LMEAl price
$3,000
25,000
$2,500
20,000
$2,000
15,000
$1,500
10,000
$1,000
5,000
$500
$-
0
LMEAl price
Al consumption (Thousand tonnes)

90

$- 0 LMEAl price Al consumption (Thousand tonnes) 90 China Consumption BRICS consumption ROW consumption LME

China Consumption

0 LMEAl price Al consumption (Thousand tonnes) 90 China Consumption BRICS consumption ROW consumption LME Al

BRICS consumption

0 LMEAl price Al consumption (Thousand tonnes) 90 China Consumption BRICS consumption ROW consumption LME Al

ROW consumption

0 LMEAl price Al consumption (Thousand tonnes) 90 China Consumption BRICS consumption ROW consumption LME Al
0 LMEAl price Al consumption (Thousand tonnes) 90 China Consumption BRICS consumption ROW consumption LME Al

LME Al price

*WBMS

0 LMEAl price Al consumption (Thousand tonnes) 90 China Consumption BRICS consumption ROW consumption LME Al

Bauxite reserves

Bauxite base reserves vs reserves (2009)

3,000,000 2,500,000 76% 2,000,000 1,500,000 30% 1,000,000 55% 500,000 80% 0 Brazil China India Russia
3,000,000
2,500,000
76%
2,000,000
1,500,000
30%
1,000,000
55%
500,000
80%
0
Brazil
China
India
Russia
Metric dry tonnes (thousands)

91

Base reserves500,000 80% 0 Brazil China India Russia Metric dry tonnes (thousands) 91 Reserves Percentage reserves Source:

Reserves80% 0 Brazil China India Russia Metric dry tonnes (thousands) 91 Base reserves Percentage reserves Source:

Percentage

reserves

0 Brazil China India Russia Metric dry tonnes (thousands) 91 Base reserves Reserves Percentage reserves Source:

Source: USGS

0 Brazil China India Russia Metric dry tonnes (thousands) 91 Base reserves Reserves Percentage reserves Source:

BRICS: trade

BRICS: trade Bauxite Aluminium 0.6 mil tonnes 0.6 mil tonnes 6 mil tonnes 9 mil tonnes
BRICS: trade Bauxite Aluminium 0.6 mil tonnes 0.6 mil tonnes 6 mil tonnes 9 mil tonnes

Bauxite

Aluminium

0.6 mil tonnes 0.6 mil tonnes 6 mil tonnes 9 mil tonnes
0.6 mil tonnes
0.6 mil tonnes
6 mil tonnes
9 mil tonnes

35 mil tonnes

1.0 mil tonnes

92

BRICS: trade Bauxite Aluminium 0.6 mil tonnes 0.6 mil tonnes 6 mil tonnes 9 mil tonnes
BRICS: trade Bauxite Aluminium 0.6 mil tonnes 0.6 mil tonnes 6 mil tonnes 9 mil tonnes

BRICS aluminium consumption: THE FUTURE

2011 = 20.8 mil tonnes; 2016e = 26.9 mil tonnes Next 5 years an extra
2011 = 20.8 mil tonnes;
2016e = 26.9 mil tonnes
Next 5 years an extra 6 mil tonnes of metal required

93

18 16 14 12 10 8 6 4 2 0 1998 2000 2002 2004 2006
18
16
14
12
10
8
6
4
2
0
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
Consumption of Al per capita (kg)

China2010 2012 2014 2016 Consumption of Al per capita (kg) CAGR: South Africa CAGR:10.3% Russia CAGR:

CAGR:

South Africa2014 2016 Consumption of Al per capita (kg) China CAGR: CAGR:10.3% Russia CAGR: 1.8% Brazil CAGR:

CAGR:10.3%

Russia

CAGR: 1.8%2016 Consumption of Al per capita (kg) China CAGR: South Africa CAGR:10.3% Russia Brazil CAGR: India

BrazilCAGR:

CAGR:

IndiaCAGR:

CAGR:

of Al per capita (kg) China CAGR: South Africa CAGR:10.3% Russia CAGR: 1.8% Brazil CAGR: India
of Al per capita (kg) China CAGR: South Africa CAGR:10.3% Russia CAGR: 1.8% Brazil CAGR: India

Where next……

35 Germany 30 South Korea 25 USA 20 Taiwan Italy G7 15 China France 10
35
Germany
30
South Korea
25
USA
20
Taiwan
Italy
G7
15
China
France
10
South Africa
Brazil
UK
Russia
India
-
-10
10
20
30
40
50
-5
Aluminium consumption (kg per capita)

94

GDP per capita (thousand US$)

UK Russia India - -10 10 20 30 40 50 -5 Aluminium consumption (kg per capita)
UK Russia India - -10 10 20 30 40 50 -5 Aluminium consumption (kg per capita)

Conclusions

• BRICS countries have all shown unprecedented increases in GDP over the last 10 yrs

• Demand for industrial metals due to growth in middle classes and large- scale construction and consumerism - but with room to grow.

• How much can we rely on China and the emerging economies? Is china slowing? Can it secure its raw materials and energy?

• What other factors should be considered and why? Eg. inflation, currencies, rising food prices….

95

and energy? • What other factors should be considered and why? Eg. inflation, currencies, rising food
and energy? • What other factors should be considered and why? Eg. inflation, currencies, rising food

Disclaimer

The information contained within this presentation is for illustrative and educational purposes only and should not be relied upon in making any investment decision. Whilst every effort has been made to ensure the information is up-to-date and correct, the LME cannot guarantee that it is completely accurate and free from human error.

is up-to-date and correct, the LME cannot guarantee that it is completely accurate and free from

96