Q+A-What will metal ETPs mean for investors, consumers?

LONDON Fri Dec 10, 2010 2:07pm GMT

LONDON Dec 10 (Reuters) - The launch of physically backed copper, tin and nickel exchange traded products on Friday has triggered a hot debate about the advantages and disadvantages for investors, consumers and producers.

For a story on the ETPs launch: [ID:nLDE6B90D6]

The listings in London by UK-based ETF Securities are aimed mainly at institutional investors such as pension funds and insurance companies looking for exposure to hard assets such as copper, used in power and construction. [ID:nLDE6B61QR]

Copper consumers complain that these products will distort market fundamentals and prices at a time when falling ore grades, disruptions and project delays mean supplies could be restricted. [ID:nLDE6B81L8]

"We're in a period in which availability is challenged. Anything that ties up physical metal and restricts end users from using copper is unhealthy," said Ian Scarlett, Luvata's head of metals, Europe and Asia. [ID:nLDE69804N]

For producers the prospect of a new source of demand could be good news, but it could mean consumers look for more metal on long-term contracts. [ID:nLDE69J0VA] [ID:nLDE69804N]

All metal will be stored in warehouses, which are approved and audited by the London Metal Exchange. [ID:nLDE69C0ID]

LME Chief Executive Martin Abbott has said that large physical base metals positions held by exchange traded products could be subject to the exchange's lending guidelines.

WHAT COULD BE THE LONG-TERM IMPACT ON BASE METAL MARKETS?

"There will not be any immediate issue for metals that are considerably oversupplied at present -- aluminium and zinc," said Richard Wilson, chairman of metals division for consultants Brook Hunt, a Wood Mackenzie company.

"But for others such as copper and tin that are in relative short supply this will lead to increased price ... volatility."

Others think the long-term impact will be neutral because the ETPs are aimed at investors who already have exposure.

They are more likely to switch from commodity-index linked investments and structured products rather than invest more.

"While the creators of ETPs stand to benefit from them, they are predominantly targeted at sophisticated investors," said Paul Robinson, group manager, non-ferrous metals at CRU Group.

"(Base) metals will continue to be driven by fundamentals."

ANY PARTICULAR METAL TO SINGLE OUT?

Copper and tin were top for most of the people interviewed by Reuters -- shortages are likely for both metals and could mean deficits, possibly starting this year.

"Copper has generated lots of interest but how do you build, hold and divest a substantial position without increasing prices as you buy," Robinson said.

INVESTOR APPETITE STRONG ENOUGH TO OVERCOME STORAGE COSTS?

For all the ETPs listed so far the management fee is 0.69 percent a year, insurance costs 0.12 percent. Storage costs for copper are 36 U.S. cents a day per tonne, for tin they are 42 cents a day and for nickel 45 cents a tonne a day.

"The fact that the launch is starting with copper, tin and nickel -- the most expensive LME commodities per tonne -- to me reflects the real impact storage costs have on potential returns," Robinson said.

COULD THE LME'S LENDING GUIDANCE AND THE FACT THAT METAL MAY BE STORED OFF WARRANT PUT INVESTORS OFF?

The guidance is designed to preserve an orderly market and govern the cost at which metal must be lent or made available to other market players by holders of dominant positions -- more than 50 percent of stock warrants and cash contracts.

To stay within the lending guidance and cut storage costs, some metal will be moved off warrant as assets build up, but initially all metal will be held as LME stock warrants.

"That to me opens the market to manipulation," said Alex Heath, head of base metals at RBC Capital markets.

"If I'm an investor and I decide I want to control the market -- I get long of just under the limit of normal futures, then I go invest a couple of hundred million dollars in an ETF, and step back and watch the fireworks."

HOW MUCH METAL COULD BE HELD IN EACH OF THE INDIVIDUAL ETPS?

Deutsche Bank said in October ETPs backed by copper could hold 300,000 to 400,000 tonnes of metal. That compares with stocks of about 350,000 tonnes in LME warehouses now.

However, as yet there is no consensus.

"Initial indications for copper suggest that a typical fund size might be 60,000-100,000 tonnes, whereas for aluminium the overall tonnage could be much higher given the sheer volume of metal held both on and off exchange," Wilson said.

WHAT OTHER ADVANTAGES ARE THERE OF THESE ETPS?

Owning metal, unlike futures, is not time-limited and the costs of rolling positions and margin calls are also removed.

Investors also have the benefit of daily liquidity.

"Exposure to base metals could be seen as a form of inflation protection or a hedge against the devaluation of the U.S. dollar," said Eugen Weinberg, head of commodities research at Commerzbank.

WHAT OTHER DISADVANTAGES ARE THERE?

Apart from price volatility, a tighter market could narrow or eliminate the discount or contango for material for nearby delivery over metal for delivery further down the maturity curve and perhaps turn it into a premium or backwardation.

"Regardless of what the dynamics of these instruments are, when you've got a $30 backwardation in copper cash MCU0 to three months CMCU3, I don't see the advantage of paying 45 cents a day when it costs nothing to roll forward a futures contract," said Daniel Major, analyst at RBS.

Analysts say another disadvantage is that investors only have access to warrants and not the actual metal.

"They're not promising you that you can get the metal ... you're just going to have to ring up the warehouse and get in the queue like everyone else," one analyst said.

"No one is going to give you a cheap rate on storage -- not on copper or tin -- not unless you own the warehouse." <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For details of ETF Securities physically backed copper, nickel, tin ETPs: here FactSheetPhysical-Copper.pdf here here here ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

(Additional reporting by Karen Norton, Michael Taylor, Melanie Burton and Marie-Louise Gumuchian; Editing by Sue Thomas)

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