Tag: Futures educational information

Ferrous metals, metals that contain iron, are distinct from both precious and base metals. They include raw materials like iron ore and steel scrap as well as semi-finished products such as hot rolled coil.

Iron Ore

Iron Ore is found in the earth’s crust and mined from open pits. China is the world’s largest producer, consumer and importer of iron ore, producing 1.3 billion metric tonnes, equivalent to 44% of the world’s output. Australia is the second-largest producer of iron ore and has the world’s largest deposits. Chinese iron ore deposits are of lower iron content than those typically found in Australia and Brazil.

Iron ore is the key ingredient in the steel making process using the blast furnace. The earliest blast furnaces date back to first century in China. In a blast furnace, which is lined with refractory brick, iron ore, coke and limestone are heated to produce liquid iron. Once a blast furnace is started, it will continuously run for years, with only short stops for planned maintenance. The temperature in a blast furnace can reach up to 4200 °F (2300 °C).

Steel is also produced via an Electric Arc Furnace (EAF) using steel scrap. About one-third of the world’s crude steel is made in an EAF. In an EAF, the scrap metal is charged using graphite electrodes to heat the metal. The temperature reaches 6300ºF (3500ºC). In the U.S., steel is typically produced using EAFs rather than blast furnaces.

Steel production using EAFs compared with primary steel production using a blast furnace has some benefits including the ability to use 100% recycled scrap feedstock, thereby being less energy-intensive and the flexibility to start and stop production being more responsive to changes in demand.

Iron Ore Market Fundamentals

Iron ore supply has been increasing over the last 10 years in response to China’s industrialization during the commodity super cycle. To meet China’s demand for iron ore, which is the key ingredient in steel making which is required for construction and white goods, world supply from iron ore mines increased.

This had an impact on the way iron ore was priced. In the decades between the 1960s and the millennium, iron ore prices were stable with plentiful supply. But China’s demand for iron ore caused prices to rise, and miners and steel makers who had traditionally agreed on annual prices following long negotiations, moved to quarterly prices in 2010 and then eventually spot pricing.

Iron ore is transported via ocean freight on capsize vessels. Some of these very large ore carriers have a deadweight capacity of 400,000 metric tonnes.

Steel

Steel scrap is collected from recyclable materials left over from product manufacturing and consumption. Scrap collection and supply is responsive to changes in price.

Steel Production

China is the world’s largest steel-producing country representing over half of all crude steel. In 2015 it produced 50.3% of the world’s 1,599.5 million metric tonnes. Japan (105.15 million metric tonnes), India (89.58 million metric tonnes), the United States (78.92 million metric tonnes) and Russia (71.11 million metric tonnes) make up the top five steel producing countries.

Steel Demand

Different types of steel are produced according to the properties required for their application, such as density, strength, thermal conductivity and elasticity. They are broadly categorized into carbon steels, alloy steels, stainless steels and tool steels. Steel is used in construction of bridges, roads, railways and buildings. It is also used in the white goods sector, which includes large electrical goods such as refrigerators and washing machines, named such because they are typically white in color.

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Peter Knight Advisor

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Base Metals Supply and Demand

Copper Production

Copper ore is found in the earth’s crust and is either mined from open pits or underground. Most of the world’s copper ore originates from Chile (approximately 30%). The Escondida copper mine in northern Chile is the world’s largest copper mine by reserve. In 2012, it had 32 million metric tons in copper reserves.

Copper ore is processed by breaking the rocks into smaller pieces and is turned into copper concentrates through the process of beneficiation. Then, through the smelting process, copper is extracted from the ore. Once copper is extracted from the smelter, it is melted and cast as anodes. High-purity copper cathodes are created from anodes in the final step of the process.

Copper is a commodity and, if meeting all specifications, can be delivered into exchange-approved warehouses.

Copper Market Fundamentals

Copper supply has increased over the last 10 years in response to China’s industrialization during the commodity “super cycle.” To meet China’s demand, world supply from copper mines doubled over the period 1994-2014. Copper’s price performance is well-linked to the performance of the Chinese economy.

Mining companies have been cutting costs since 2003, and with any fall in demand, cutting the cost of production has been a way to maintain profitability. The collapse of oil prices from $115 per barrel in June 2014 to under $35 in February 2016 also reduced the price of copper because mining and refining are energy-intensive. The currencies of copper-producing countries have fallen, down 10.4% in 2014 from 2013, and down by 13.4% in 2015 from 2014 (USGS, Bloomberg, CME Group). This would have reduced labor costs.

Copper is widely used in both industrial and commercial markets, from electronics and plumbing to power generation, and is viewed as a reliable indicator of economic health. Copper is often referred to as Dr. Copper because of its ability to predict turning points in the global economy.

Other factors that positively impact copper demand are government-backed copper, intensive power infrastructure, home appliance subsidy schemes, and promotion of electric vehicles. The growth in urban population with higher disposable incomes increases demand for buildings, home appliances and consumer electronics.

Aluminum Production

China is the world’s largest aluminum producer, representing 54% of the world’s 58 million metric ton production in 2016, based on International Aluminium Institute data.

Aluminum is produced through the electrolysis of bauxite (aluminum ore). Australia is the number one bauxite producer, followed by China and Brazil. Bauxite is mined, crushed and processed to remove silicon impurities.

Alumina, the common name for aluminum oxide, is extracted from bauxite. Alumina is extracted through aluminum smelting by the Hall-Héroult electrolysis process. This requires a great deal of energy and smelters are often located near hydro-electric power plants. Primary aluminum is then cast into ingots or used in alloys.

Aluminum is a commodity and, if meeting all specifications, can be delivered into exchange-approved warehouses.

Aluminum Market Fundamentals

The production of aluminum has shifted to China over the last 15 years. During this period, demand increased ninefold.

China is therefore both a producer and consumer of aluminum. Currently, there is an over-supply of global aluminum, which has put global prices under pressure.

The production of aluminum requires tremendous amounts of electricity. Many smelters in China connect directly to the electrical grid and provide a baseline power demand for underserviced regions in the country. In China, aluminum production serves more than one purpose; it provides the metal for the domestic market, powers communities and provides jobs and economic growth for many municipalities.

The cost of production in China was around $1550/mt and at the start of 2016 and 35% of producers operated at a loss.

Regional differences in aluminum markets are clear when you compare China to the U.S., which is currently in a structural deficit. Aluminum producers have fared better than copper producers because they have cut production and reduced inefficiencies in response to the lower prices and high stockpiles. Demand for automotive vehicles, which are increasingly aluminum intensive, power transmission investment, housing development and electrical appliances create aluminum demand.

In the U.S., the substitution of aluminum for steel in car manufacturing, such as Ford’s F-150 model, will be positive for demand. Whereas the fall in consumption of carbonated soda drinks, the largest share of demand for can sheet in North America, will weigh on the aluminum demand.

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Peter Knight Advisor

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Introduction to Base Metals

Introduction to Base Metals

Base metals are non-ferrous industrial metals including copper, aluminum, lead, nickel, tin and zinc.

Common Usage of Base Metals

Base metals appear in industrial and commercial applications.

Copper – commonly used in wiring in electrical equipment due to its excellent conductivity.
Aluminum – commonly used in the transportation industry for use in aircraft, cars and bicycles. Being largely resistant to corrosion, aluminum is also used in the food and beverage industry for drinks cans, kitchen foil and packaging.
Lead – is soft, highly malleable and ductile and is predominantly used commercially in the manufacture of batteries.
Zinc – often used in alloys, where a metal is made by combining two or more metallic elements to give improved properties, creating brass by combining zinc with copper. Zinc alloys are often used in industries such as shipbuilding and commercial uses in cars, electrical components and household fixtures.

Who Trades Base Metals?

Different types of firms are actively engaged in Base Metals trading for a variety of reasons. Some firms are hedging a physical price exposure due to their involvement in the supply chain of the metal. Others trade Base Metals as an investment asset.

Trading Base Metals

There are two main ways to manage risk in the base metals markets: by trading futures and options with CME Group, or by trading forwards over the counter. Our base metals futures and options cover a wide range of products and are either physically-delivered or cash-settled using price reporting agency indexes or assessments.

Futures contracts are standardized contracts for the purchase and sale of financial instruments or physical commodities for future delivery on a regulated commodity futures exchange.

Forward contracts are customized contracts between two parties to buy or sell assets at a specified price on a future date and are privately negotiated and traded over-the-counter.

Futures and forwards contracts are similar in nature but note the benefits of trading futures over forwards.

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Peter Knight Advisor

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Trading the Metals Markets

Trading the Metals Markets

The metals market is really several markets. Precious metals such as gold and silver are often thought of as jewelry markets while base metals such as copper go into homes and manufacturing. Platinum and palladium are precious metals, but are used in automobiles while gold is many things to many people – a currency, an inflation hedge, a barometer of the economy, a central bank tool and of course, a commodity.

Collectively, metals markets offer investors access to truly global markets that are connected to everything from the computer industry to construction to macro-economics and geopolitics. This brings in a broad range of participants from commercial hedgers, to central banks to institutional traders and individuals looking for opportunities and diversity. The markets are sometimes volatile and unpredictable, which means they also offer flexible and creative trading opportunities, as well as ways to protect and hedge against broader moves in the stock and commodities sectors. Traders looking to tap into this major global commodity sector access to precious and base metal futures virtually 24-hours per day

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Peter Knight Advisor

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Platinum Product Overview

About Platinum Futures

Platinum futures (PL) at CME Group are an integral part of the global metals market.

With annual production totaling 5% of gold’s annual production and 1% of silver’s annual production, platinum is one of the rarest metals on earth. This extremely rare metal has a variety of uses in transportation and in the manufacture of jewelry and electronics.

The Contract

Each NYMEX Platinum futures contract represents 50 troy ounces of deliverable platinum, with a minimum tick price of $5.00. The contract trades electronically nearly around the clock, six days a week, and traders are able to leverage substantial margin efficiencies when gaining exposure to this liquid market.

Supply and Demand

Production of platinum is highly concentrated, with South Africa and Russia producing 70% and 15% of the annual supply, respectively.

Consequently, the supply, and in turn the price, of platinum fluctuates with the political stability of these countries. The demand for platinum is primarily influenced by its industrial uses.

Catalytic converters, automotive devices that reduce pollution, account for 45% of platinum’s demand. As environmental regulations become more stringent, demand and use for platinum may rise.

Additionally, with its many uses in the technology sector, the metal may move in concert with the broader economy. Platinum’s price is particularly attuned to the strength or weakness of the Japanese economy: 30% of platinum is used for jewelry manufacturing and Japan demands 95% of this jewelry.

Traders looking to take a position in a rare metal that offers some exposure to the broad economy have a valuable tool in the platinum futures contract.

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Regards,
Peter Knight Advisor

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Silver Product Overview

About Silver Futures

Silver futures (SI) are a valuable tool for investors looking for a precious metal that serves as an inflation hedge while also possessing many industrial applications.

Silver is the most extensively produced precious metal in history and has been mined for six millennia.

Historically, it has often served as a currency and thus it shares many of the inflation-hedge and safe haven qualities of gold. However, unlike gold, which is primarily used in jewelry, silver is widely used in industry as manufactures capitalize on its superior electrical conductivity.

Each NYMEX Silver futures contract represents 5,000 troy ounces of deliverable silver, with a minimum tick price of $10.00 per contract. The contract trades electronically nearly around-the-clock, six days a week, and traders are able to leverage substantial margin efficiencies when gaining exposure to this liquid market.

Silver Supply and Demand

The production of silver is widely diversified across many countries and continents, which helps prevent surprising variations in supply.

However, as silver production is the byproduct of copper, lead and zinc mining, when those metals experience decreased production, silver often rallies. The demand for silver is largely impacted by needs of the industry.

As the best conductor available, even besting copper, around 50% of silver demand is used in the manufacture of electrical appliances and circuitry.

Consequently, the price of silver often moves in partner with the tech sector and the broad economy. Approximately a quarter of the silver supply is used in jewelry and the tableware products.

These practical applications make silver an attractive addition to a portfolio for its capital appreciation qualities. Additionally, silver’s precious metal status help it rise in price as currencies decline in value, which makes silver an optimal instrument for capital preservation.

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Peter Knight Advisor

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Gold Product Overview

Learn about Gold Futures

Gold futures, ticker symbol GC, are among the most widely traded futures products worldwide. Although Gold futures are contracts for physically-deliverable commodities, these products are also critical tools for diversifying portfolios and mitigating risk. Traditionally, gold has been seen as a “safe haven” in times of global economic or political uncertainty, and as such, prices may often move inverse to the U.S. dollar, treasury bonds, and U.S. stock indexes.

The Contract

Each COMEX Gold futures contract represents 100 troy ounces of deliverable gold, with a minimum tick price of $10.00. The E-micro Gold futures contract, symbol MGC, represents 10 troy ounces of gold and trades at a minimum tick price of $1.00. The contracts trade electronically nearly around the clock, six days a week, and traders can leverage substantial margin efficiencies when gaining exposure to this liquid market.

Trading the Contract

Market participants actively trading Gold futures must pay attention to numerous macro factors, both economic and political. U.S. economic and monetary policy, as well as the overall health of the U.S. economy, can heavily impact gold prices, so traders leveraging gold must pay close attention data points such as FOMC statements, inflationary indicators like CPI and PPI, and non-farm payrolls numbers.

Since gold is also used as a hedge for non-U.S. economies, traders must also be highly attuned to issues of political and economic stability worldwide, especially in China, Japan, the Middle East and the Eurozone.

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Peter Knight Advisor

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Fundamentals and Metal Futures

Fundamentals and Metals Futures

The fundamental analyst will look at certain factors to determine where the price of metals like gold and silver might move in the future

There are a few unique factors that the fundamental analyst will use to evaluate trades in the metals futures market, including investment and manufacturing demand.

Uses and Movement of Metals

Many of the metals traded in the futures market are sought after for investment purposes and industrial applications.

The supply and demand of metal futures will be influenced by people using metals as a speculative investment, and those using metals as an input in manufacturing processes. For metals like gold and silver, there is also strong demand from ETFs and other investment funds, as investor appetite for precious metals increases.

For example, gold is used as a speculative investment and in the manufacturing of goods like jewelry and electronics. Gold has always been a unique metal, used as a currency and as a store of value to combat inflation.

Contrast that to copper, where investment demand is virtually non-existent, but the industrial demand is high. The fundamental analyst in this case will look at demand coming from the construction and other industries rather than focusing on copper as an investment.

The demand from each of these sources might move in the same direction at times and in opposite directions at other times.

For example, if the economy is growing rapidly and inflation is increasing, the investment demand for gold might increase as investors buy gold to hedge against inflation. At the same time, the growing economy will most likely create increased demand for industrial gold as consumers buy more products that contain gold.

But, if the economy is contracting, demand for investment gold is likely to increase as investors purchase gold as a stable investment as the equity markets show signs of weakness. At the same time, industrial demand may decrease as consumers demand fewer products in a weakening economy.

Supply

Supply is important for metals, but typically demand is the primary driver of price. The overall supply of metals is limited, but the fact that metals can be melted and reused increases the available supply as existing metals are re-melted, lessening the reliance on new production and smoothing out the supply cycle.

For example, once corn is fed to livestock, it is removed from the supply chain and new corn must replace it. But since metals can be reused virtually forever, the metals market supply comes from existing and newly mined inventory.

Demand

The main factors effecting demand for metals are economic. Factors such as GDP, inflation and interest rates all play a factor in both industrial and investment demand for metals.

Each of these factors will affect a particular metal differently. Some metals, like gold, will be impacted by all of these economic factors, whereas other metals will not be impacted in the same way. The demand for gold will respond to different factors than the demand for platinum.

Conclusion

Fundamental analysts evaluate a variety of factors, to determine which factors hold more weight than others, and then make trading decisions based on these opinions.

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Peter Knight Advisor

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Stock Index Education Home Page

Fundamentals and Equity Index Futures

Fundamentals and Equity Index Futures

Fundamentals are important in the analysis of a futures contract price. Each futures market will have unique fundamental factors that will affect price.

One such contract is E-mini S&P 500 Index futures, ticker symbol ES. It is based on the S&P 500 Index, which is made up of the 500 largest U.S. companies, based on market capitalization.

A fundamental trader will review macro-economic data as well as individual conditions for specific stocks that are held within the S&P 500 Index to make decisions about whether to buy or sell the ES futures contract.

Economic Factors

Factors such as GDP, inflation, interest rates and unemployment rates are some of the influences that will affect the economy, and thus influence individual stocks, leading to the price of an equity index to either increase or decrease.

While these factors may influence on companies, and ultimately the equity indexes, they do not directly affect companies or the futures contracts, e.g. just because interest rates increase, does not mean equity index futures will decrease in price. The influence is created by the interaction of the economy, which influences a company’s financials and the price of the futures contract in the long run.

Traders will analyze available economic data and create a trading strategy based on the behaviors they expect from the data. For example, if unemployment rates are high, people are less willing to spend money on certain items, which means the companies in these sectors may see sales, and ultimately stock price, decrease. If the price of enough companies move down, the price of the index will also move down.

Stock Price

Since equity index futures are based on the price of the underlying companies, a fundamental trader will attempt to determine how a company’s current stock price will be affected by its future outlook. If the trader believes that there will be growth in the economy for the next few years they will incorporate that assumption in to their analysis of the futures contract.

Stock prices move up and down based on the financial health of a company, the stock price of a company now is based on the estimated future earnings of the company.

If the company is financially strong, they should see earnings grow over time and see their stock price increase as well. If the company expects lower earnings in the future, their stock price should move down. These are the most basic relationships, and the reactions of the futures contracts over time might be different than the model, since futures markets are complex and sometimes move in different directions than predicted.

One Factor, Multiple Outcomes

Some macroeconomic factors might have more than one effect on the equity indexes. The immediate reaction might be different than the reaction that happens over time.

For example, if GDP increases too quickly, the government might be tempted to increase interest rates to try and cool down the economy. This will lead to equity index futures decreasing in price in the long-term.

Some factors that influence ES futures in the short-term might have an opposite effect in the long-term. The analyst will tailor their projections to the timeframe they plan on holding their trade. The trader will make assumptions based on the intended length of time they plan on holding the trade. If the trade is a short-term trade of a few weeks the trader might come up with a very different assumption than if the trader is planning on holding the trade for a year or more.

Conclusion

The modern economy makes equity indices a more complex futures contract to analyze, because there are a lot of variables for a fundamental trader to incorporate in the analysis.

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Peter Knight Advisor

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Stock Index Education Home Page

Beta Replication and Smart Beta

Beta

Beta describes the return achieved from exposure to the overall market, e.g., via an index fund. It is also a measure of the relative volatility of a stock compared to the whole market.

Stock index futures, especially E-mini S&P 500 futures, are the institutional choice for beta replication and can allow investors large and small to achieve the elusive goal of cheap beta. Beta can now be sourced efficiently and cheaply around-the-clock in nearly any major stock index.

The market in this case is the S&P 500. If a stock has a beta of 1.20, it is 20% more volatile than the S&P 500. If the S&P 500 was up 10%, a stock with a beta of 1.20 would be expected to rise by 12%. If a stock has a beta of .80, it is only 80% as volatile as the whole market. If the S&P 500 advanced by 10%, a stock with a beta of .80 would be expected to rise only 8%.

An S&P 500 Index fund, which owns each of the 500 members of the index, has a beta of exactly 1.00. Hence, if an investor was “buying beta,” it would refer to investing in the whole market, usually through derivatives such as S&P 500 futures. If an investor wanted exposure to small cap beta, he might obtain this through E-mini Russell 2000 futures.

Futures are a cheap and efficient way to obtain beta exposure. In fact, investors can replicate exposure in just about any type of market.

Beta or Exposure Sought	Beta source or primary underlying index	Cheapest beta for replication
MidCap Stocks	S&P MidCap 400	S&P MidCap 400 Futures
Small Cap Stocks	Russell 2000 Index	Russell 2000 Futures
Large Cap Stocks	S&P 500 Index	S&P 500 Index Futures
Japanese Stocks	Topix or Nikkei 225 Index	Nikkei 225 futures/Topix futures

While other sources for beta replication (swaps/options/ETFs) exist, futures offer the best combination of efficiency, liquidity and low transaction costs.

Next Generation Beta — Smart Beta

The latest evolution in passive investing goes beyond plain vanilla passive investing. Smart beta is an approach that tries to enhance the return from tracking an asset class by deviating from the traditional cap-weighted approach, in which investors simply buy shares or bonds in proportion to their market value in their respective index.

Fundamental indexing, where each component stock might be weighed according to their earnings or price-to-sales ratios, are part of many smart beta strategies.

Equal-weighted indices are another strategy and can help prevent overweighting caused by the most successful stocks in an index. As time progresses, successful companies can become over-weighted in their indices. This can cause balance issues and a portfolio that is biased toward the successful larger-cap companies.

As fundamental indexing and new generations of beta appear, look for more innovative products going forward including futures contracts and derivatives on such products

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Peter Knight Advisor

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