Unstoppable rise in metal prices is giving rise to a precarious situation; it is pushing away genuine hedging.

Data show that investors’ interest in metals have reached at the highest in many years. For example, net speculative Copper positions in CME is at highest level since Jan 2018. Further, enthusiasm over China-led industrial recovery is bringing up forecasts of new bull market. Some see rerun of 2000s when metal prices began riding a large wave, led by massive infrastructure spending by China.

The unstoppable rise in metal prices is giving headache to metal businesses. These companies, who genuinely hedge their exposure by taking an offsetting position at LME, are finding it difficult to fund Mark-to-Market losses to the LME broker to defend their hedges. The cash outflow is negatively affecting their working capital and thereby businesses. The problem is grave especially for medium scale businesses.

“Funds and speculators are long; trade clients/manufacturers are short. Clients are telling us that working capital requirement has increased. This is stressful”, said a London based category 1 broker of LME.

Metal Intelligence Centre (MIC) gathers that in some cases businesses are forced to unwind or lower their genuine hedging portfolio either because this is undermining their businesses or because they can’t afford more cash outflows.

“One-sided move in prices is bad for my business for many reasons. First, mark-to-market outflows are draining liquidity and affecting normal business operations. Second, brokers are becoming worried. Even one day of delay in meeting margin calls is not acceptable to them. Lastly, customers – who have pricing options – are not pricing in hope of lower prices, nor are they giving collateral. This increases our exposure on them”, said Kamlesh Jain of Jain Metal Group. In some other cases, overseas vendors are stopping to provide pricing options to customers as the time lag leads to mark-to-market outflows to their brokers.

“Numerous small and medium size traders are removing their hedges and forcing their buyers to price the material early as they are unable to pay daily margin calls. Further many sellers are wanting to sell the material at fixed prices to avoid paying for margins”, said Ashish Bansal, MD of Pondy Oxides and Chemicals Limited. Hedgers are generally prepared for these eventualities. However, a quick, incessant and one-way rise of prices, beyond business’ cashflow generation capacity, is punishing.

“Everyday’s margin calls test our systems, requiring us to set aside some cash for future adverse movements in prices. Also, loss on hedging is not immediately absorbed by customers; this puts pressure on the margins thus bringing further mismatch in cashflows”, said Anirudh Agrawal, Director of Manaksia Aluminium Limited.

Not only in the futures markets, investors are crowding out hedgers in physical markets as well; thanks to cheap money.

MIC’s calculations show that 2.5-3 million tons of Copper has been stockpiled in China. Also, despite about 3 million tons of surplus this year (according to CRU), Aluminium is in short supply in China; warehouse queues are as long as 70 days. Macquarie reports that about 1 million tons of Zinc are stored in private warehouses, away from consumers. These are helping build an “artificial shortage” of metal and nurturing bullish sentiment.

Investors’ excitement is punishing the real business that underlie the futures markets and the spirit of risk management. This is not in long-term interest of the industry.

The big question is whether physical fundamentals will fight back? Whether high prices will slow consumption and raise supplies? Although shades of these are visible, more is needed to stop the juggernaut of the bulls. Possibly, next year holds more interesting stories in this regard.

Author is Founder, CEO of Metal Intelligence Centre (MIC), an information hub for metals

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