Value in derivatives market

Hong Kong-based Perfect Hexagon to boost local derivatives market, targeting precious metals, the London Metal Exchange and palm oil products.

WITH the financial market looking uncertain in the near term, analysts see derivatives instruments as useful for investors to manage their risk.

“By hedging with a derivatives contract, market participants can reduce uncertainty on the future price of a commodity, security or financial instrument,” said CGSCIMB futures Sdn Bhd head of futures broking David Tan.

He said derivatives contracts are one of the most popular asset classes being used to offset market risk exposure and protect themselves from market volatility.

In the commodity market, both consumers and producers of a commodity can use futures contracts to hedge without having to hold the physical commodity.

“Say a producer has been contracted to deliver physical crude palm oil (CPO) in six months’ time by December 2020 and wants to lock in the current CPO price at RM2,330 per tonne.

“To hedge against any fall in CPO prices until December 2020, the producer can sell his December 2020 CPO futures contract at the current price of RM2,330.

“If CPO prices fall to RM2,300 by

December 2020, the lower physical sales price by RM30 would be offset by the gains of RM30 in the futures contract,” Tan told Starbizweek.

The same situation also applies to consumers who worry about the volatility of the commodity market. They can buy CPO futures at lower prices today that could offset higher CPO prices in the coming months, he added.

While it is apparent that derivatives markets provide a useful tool for hedging, especially in the commodity market, awareness level among investors on derivatives markets is still lacking.

Bursa Malaysia Derivatives Bhd (BMD) chairman Datuk Muhamad Umar Swift said that market and product awareness needs to be increased to encourage more institutional users to use derivatives instruments as a risk management tool.

“Continuous efforts are being made to engage with the industry and promote the use of derivatives products for risk management,” he said.

For instance, BMD has been the host of Malaysia’s largest palm oil industry conference – the Palm and

Lauric Oils Price Outlook Conference & Exhibition (POC) – for 30 years, as part of its promotional activity.

Muhammad Umar said that intense competition from foreign derivatives exchanges is also a challenge to grow the local market.

To further enhance the local market, he said BMD has been working to expand its international presence.

“We will further enhance our effort to promote our derivatives products to foreign proprietary trading firms, hedge funds and commercial firms, and introduce foreign futures brokers to Malaysian counterparts in our bid to forge new inter-broke relationships for potential business opportunities in the future.

“Our internationalisation effort includes market entry into Greater China through various collaborations with various parties,” he said.

BMD recently partnered with Hong Kong-based Perfect Hexagon Ltd to be a market maker for commodity derivatives to enhance liquidity.

Perfect Hexagon also received approval and has successfully registered as an Associate Participant of BMD effective May 13, 2020.

“As an Associate Participant of BMD, Perfect Hexagon will be providing liquidity to the Bursa platform through different products listed via our extensive experience and networks.

“In short, we play the role as a market maker in BMD,” said Perfect Hexagon director and chief executive officer Sim Tze Jye.

Perfect Hexagon is a recognised leader in commodity trading globally.

“In our relentless pursuit to enhance our services to our clients in all continents, we began participating directly in key exchanges since 2016.

“Within a short time frame, we have been on board the Singapore Bullion Market Association (SBMA), Chicago Mercantile Exchange (CME) and London Metal Exchange (LME), Hong Kong Exchange (HKEX) in different products and type of memberships,” Sim said.

On the difference between investing in derivatives and the stock market, Sim said derivatives instruments are an alternative asset class to invest in compared to stocks for diversification, as it offers direct exposure to asset prices, for example commodities.

“Investors can look for arbitrage opportunities through gaps in the wide range of derivative products and markets.

“Most importantly, derivatives should be used as a risk managing tool for investors to hedge,” he said.

He reckons that palm oil is one of the key products for the Malaysian derivatives market, as it is an alternative product to sunflower oil and soybean oil.

“We foresee it will perform better in the post Covid-19 pandemic environment as the food supply chain is one of the key industries being affected.

“Food production-related industry players will look more into palm oil supply due to easier access to goods, which will result in further growth in palm oil volume,” Sim said.

“Now is the perfect time to enabling infrustructure and to be ready when the economy is in full swing again after the Covid-19 situation,” he added. – Intan Farhana Zainul

Money lending in vogue?

THE money-lending business seems to have latched on among listed companies on Bursa Malaysia.

DWL Resources Bhd is the latest listed company to join the bandwagon of companies that have gone into money lending as among their core businesses. The other newcomer to the block is MAA Group Bhd, which also offers factoring and leasing facilities.

DWL, which is into production of ceramic materials, property investment and construction activities, announced that money lending will potentially contribute 25% or more of the company’s net profit.

The company envisaged that the money lending business would require working capital of Rm20mil in the future.

MAA, which is also into education business, has so far set aside Rm13mil and Rm31.2ml respectively for the money lending and factoring and leasing businesses. In the latest announcement, it is seeking more money as working capital for all three segments of business.

MAA is cash rich from the disposal of MAA Takaful Insurance to Zurich, a deal that was completed in 2018. It received a net sum of Rm364mil from the sale. At one point, the major shareholders of MAA wanted to take the company private but failed.

As for DWL, it really does not really have a solid core business. The major shareholder is in the business of supplying foreign labour. However, the foreign labour business is not part of DWL.

The rationale for companies to go into the money lending business is simple – the returns are good. But so is the risk. Collection can be a major problem, especially if the amount is high.

Hence the money lending business needs a good clientele and experienced people with the knowledge on how to collateralised the loans.

There is always demand for credit as the banks and formal financial institutions do not serve all and sundry.

And people turn to money lending companies because they are not such a good credit to the banks.

Both DWL and MAA are new entrants to the business that is already competitive.

There are many companies that fail to recover the loans and folded up. A good example is Magnum, which closed its money lending operations some 20 years ago, after incurring huge losses.

The oil demand factor

AFTER imposing stay-at-home orders to flatten the spread of Covid-19, many countries are now re-opening their economies, turning the attention to oil demand recovery.

Sentiment on the oil and gas sector has turned slightly more favourable going by the interest on such shares in our stock market.

Many agree that the worst is possibly over considering the way the price of crude oil is trending.

That in turn is related to the gradual lifting of lockdowns around the world, coupled with sustained production cuts from Opec+ and its allies.

For this year analysts foresee Brent oil pricing to trade in the range of US$30-US$35 per barrel and to remain flattish at US$35 per barrel going into 2021.

However, the path to economic recovery is still fragile – meaning that oil demand may not return to its pre-pandemic peak levels in the near future.

Consumer behaviour is changing and currently many economies are undergoing structural changes in daily life to cope with Covid19. One of the major oil buyers is the aviation industry.

While airline demand is slowly coming back, the pick-up is seen to be gradual as there is still a fear of flying due to the virus.

Air travel is unlikely to be as robust as before. The shift towards remote working in the near term could likely impact on consumption for oil too.

For upstream O&G service providers, the path to recovery is seen as tricky given that oil majors, including Malaysia’s national oil company Petronas have undertaken capex cuts.

Then there is the risk of non-adherence to production cuts by Opec+ and allies member countries or divergence in the intentions of Russia and Saudi Arabia.

Against this backdrop, investors are advised to treat the oil and gas recovery play with caution considering that some stocks have run ahead of their valuations during the recent rally.

Companies with strong balance sheets or sustainable cash flows would be able to ride the current downcycle.

This is because near-term earnings outlook for upstream service providers remain bleak given potential margin squeeze due to greater competition now with fewer jobs out there.

THE rush by public-listed companies to get involved in making products tailored to the against the pandemic is not ceasing.

ACO Group Bhd is one of the latest jumping on the bandwagon. This week the company said it has entered into a collaboration to distribute Covid-19 rapid test kits.

Also this week, Seacera Group Bhds said it secured rights from Xidelang Holdings Ltd to resell and distribute protective clothing products in Malaysia.

Both company stocks prices climbed up this week.

But what investors ought to know is that with increasing number of players securing distribution rights to Covid-19 test kits and increasing number of people producing personal protective equipment (PPE), the margins from such ventures are bound to be minimal.

There are even non profit organisations helping disenfranchised people produce PPES at low cost and selling them at reasonable prices, especially to front line staff. As far as rapid test kits are concerned, there are an increasing number of people distributing them in the market.

Margins must be getting squeezed. Furthermore, despite some of these kits being said to be endorsed by the health authorities, it should be noted that the Health Ministry has said that said it does not recommend the usage of the antibody rapid test kits (RTK) for the screening of Covid-19, as a negative test result does not guarantee the individual is free of the virus.

The Director-general has said that the tests that are recommended for screening purposes are the antigen RTK test and the reverse-transcription polymerase chain reaction (RT PCR) test, both of which require the usage of a nasopharyngeal swab by a trained personnel.

He said that the antibody RTK test, which uses a finger-prick method, cannot be used to detect active infections.