Alu­minium a mar­ket sleeper

The Weekend Australian - Travel - - Resources - James Dunn

TMay. Only alu­minium — the ‘‘ pariah’’ of the LME ac­cord­ing to the an­a­lysts at Gold­man Sachs JBWere — is lan­guish­ing, 40 per cent be­low its 1988 high.

This is eas­ily ex­plained by the fact that stocks of alu­minium have risen by 136,300 tonnes — al­most 20 per cent — since the start of the year, to reach 835,600 tonnes.

Not sur­pris­ingly, alu­minium is one of the most com­mon of the base met­als to trade, with its pro­duc­tion and con­sump­tion dwarf­ing that of the oth­ers.

‘‘ In­vestors are hook­ing on to the cop­per and nickel story at the mo­ment, but they’re ig­nor­ing alu­minium be­cause there’s so much of it,’’ says Jonathan Bar­ratt, man­ag­ing di­rec­tor of Syd­ney-based Com­mod­ity Broking Ser­vices. ‘‘ Alu­minium is in such a large sur­plus, it sim­ply doesn’t have the volatil­ity that some spec­u­la­tors want to see. How­ever, the flip side to this is that your po­si­tions are con­trol­lable. The at­trac­tion to trade alu­minium is that it’s a very liq­uid mar­ket, and if you’re look­ing for a rise, it’s more of a grad­ual process com­pared to other met­als. On this cur­rent mar­ket, if you’re look­ing for it to trade to $US2900 a tonne — maybe even $3000 — you may be wait­ing a while, be­cause the de­mand/sup­ply sit­u­a­tion is not go­ing to turn in your favour soon.’’

In­vestors can trade alu­minium fu­tures on the LME it­self: the nor­mal con­tract size is 25 tonnes, with a min­i­mum tick (price move) of 50 cents a tonne. But re­cently the LME in­tro­duced an LMEmini con­tract, a cash-set­tled, elec­tron­i­cally traded con­tract of five tones and a min­i­mum tick of $1 a tonne.

Bar­ratt says LMEmi­nis are de­signed to ap­peal to mar­ket par­tic­i­pants who like to trade on the LME with smaller, non-phys­i­cally de­liv­er­able con­tracts, which are set­tled in a sim­i­lar fash­ion to non-de­liv­er­able fu­tures con­tracts. ‘‘ The minis are cash-set­tled con­tracts, so you’re not go­ing to end up hav­ing to de­liver or take de­liv­ery of alu­minium. It’s a good way to par­tic­i­pate in the mar­ket and not wind up with alu­minium in­gots be­ing dropped off in your drive­way.’’

With the three-month alu­minium price at $US2828 a tonne, a mini-con­tract over alu­minium rep­re­sents a po­si­tion worth $14,140. The de­posit re­quire­ment is ap­prox­i­mately 10 per cent of that, or $1414: this mar­gin must be main­tained at all times. For ev­ery $1 that the alu­minium price rises, the in­vestor makes $5.

It’s an in­no­va­tive approach by the LME, as trad­ing in the tra­di­tional con­tract can be­come cum­ber­some if it is not fully un­der­stood. The tra­di­tional LME three­month con­tracts trade each day out un­til the de­liv­ery date: you buy the LMEmini for expiry in three months, a date that be­comes your prompt’ date for de­liv­ery. The next day has a new prompt date. It’s not a tra­di­tional fu­tures con­tract as such, al­though it has a fu­tures sce­nario in terms of the lever­age,’’ says Bar­ratt.

Where a tra­di­tional fu­tures con­tract is set­tled on a known date and ev­ery­one trades to that date, each LMEmini con­tract has its own prompt date. Bar­ratt says the mini is a far sim­pler approach to trad­ing and gain­ing ex­po­sure to the base met­als mar­kets.

In a tra­di­tional LME con­tract, if the mar­ket is in HE Lon­don Metal Ex­change is a heady place for spec­u­la­tors. Nickel, tin and lead have all touched all-time highs, cop­per was re­cently at its high­est level for 11 months, and zinc saw prices rise by 11 per cent in the first week of con­tango (where the price for fu­ture de­liv­ery is higher than the spot price) the in­vestor re­ceives some of that con­tango back, on a per-day ba­sis for as long as you held the con­tract, plus your profit on the con­tract. But if the mar­ket is in back­war­da­tion (where the price for fu­ture de­liv­ery is lower than the spot price) the back­war­da­tion per day will come out of the profit on the in­vestor’s con­tract. In an LMEmini the con­tango/back­war­da­tion is im­plicit in the con­tract price, mak­ing it eas­ier to un­der­stand for the trader.’’

‘‘ It’s very liq­uid, be­cause you have mar­ket-mak­ers who spe­cialise in buy­ing and sell­ing the prompt dates, and it’s a good, steady hedge mar­ket that’s used by a lot of alu­minium pro­duc­ers to hedge,’’ says Bar­ratt.

For spec­u­la­tive-minded in­vestors who want a sim­ple lever­aged in­vest­ment in alu­minium, con­tracts for dif­fer­ence (CFDs) and spread bet­ting are eas­ily ac­ces­si­ble. An alu­minium con­tract for dif­fer­ence (CFD) is a fi­nan­cial deriva­tive that rep­re­sents a the­o­ret­i­cal or­der to buy or sell the equiv­a­lent of 25 tonnes of pri­mary alu­minium on the LME. The tick is US25 cents, while a ‘‘ point’ move is $1.

With three-month alu­minium quoted at US$2828$2838 a tonne, a trader bullish on alu­minium ‘‘ buys’ a CFD for 25 tonnes at the of­fer price of $2838, for a to­tal po­si­tion of $70,950. (If you think alu­minium will fall in price, you would sell at $2828.) The mar­gin for alu­minium CFDs is 200 points — you’re cov­er­ing a 200-point move in the mar­ket — which means $25 times 200, or $5000, that you need to cover when you es­tab­lish your po­si­tion, and main­tain.

For ev­ery $1 that alu­minium rises, the trader makes $25: but for ev­ery $1 that alu­minium falls, the loss is $25. To take a profit in the fu­ture, the trader closes the trade by ‘‘ sell­ing’ the CFD at the new bid price.

Say it is a month on, and IG now quotes three-month alu­minium at $2860-$2870. To close the trade, you ‘‘ sell’ your lot of 25 tonnes at $2860.

Your profit is cal­cu­lated as fol­lows: Clos­ing price: $2860 Open­ing price $2838 Dif­fer­ence: 22 points Profit: 22 x 25 = $550

A bear­ish in­vestor would ‘‘ sell’ alu­minium at $2828, and close the trade by ‘‘ buy­ing’ at the up­per end of the new quote, which would have to be lower than $2828 for the trade to be prof­itable.

‘‘ It’s ef­fec­tively a fu­tures con­tract, all the fi­nanc­ing is taken into ac­count and you’re only charged the spread (the dif­fer­ence be­tween the buy and sell price),’’ says Martin Batur, se­nior dealer at IG Mar­kets. ‘‘ There is a spot price, but all LME quotes are a three-month quote. Even though you’ve bought a three-month con­tract, you can al­ways get out at any time. We’ll work out whether it’s trad­ing con­tango or back­war­da­tion, which is given by the mar­ket, and then we’ll make our quote.

‘‘ So the price for your expiry date might be our three­month quote mi­nus 20 points, if the mar­ket is in con­tango, but if there was a short-term sup­ply shock and the mar­ket moved into back­war­da­tion briefly, your price can ac­tu­ally be­come 30-40 points above the three-month quote.’’ Batur says the move from con­tango to back­war­da­tion — from a dis­count to the three-month price to a pre­mium — can cut into your profit if you’re not care­ful.

‘‘ But on the flip side, you can take ad­van­tage of it, too. If you want to spec­u­late in LME met­als, which trade on a three-month ba­sis, this vari­able is some­thing you’ve got to be aware of. Say the un­der­ly­ing spot price has risen by 10 per cent: if you’re long, a move from con­tango to back­war­da­tion can re­duce your profit on this move. If you’re short, it can re­duce your loss from this rise in the un­der­ly­ing.’’

An even sim­pler mode of spec­u­la­tion is sim­ply spread bet­ting on alu­minium, of­fered by IG In­dex. Here, the in­vestor can deal in as lit­tle as $5 a point. Again, an in­vestor bullish on alu­minium would ‘‘ buy’ at the sell quote: if the three-month alu­minium price rises by $10, the in­vestor makes $50. If it drops 10 cents, he loses $50.

‘‘ CFDs and spread bet­ting are the cheap­est lever­age avail­able in met­als,’’ says Batur.

The at­trac­tion of spread bet­ting is that prof­its are free of cap­i­tal gains and in­come tax, un­less you are deemed by the Aus­tralian Tax­a­tion Of­fice to be a pro­fes­sional gam­bler. But the corol­lary of no tax on the prof­its is that any losses are not tax-de­ductible. The Aus­tralian Tax­a­tion Of­fice says that the is­sue of the tax sta­tus of spread bet­ting is ‘‘ still be­ing looked at’’, and IG In­dex rec­om­mends that in­vestors seek their own tax ad­vice.

Spec­u­late: You can buy with­out ever need­ing to take de­liv­ery at the Lon­don Metal Ex­change

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