Steel Futures - The true benchmark for industrial activity.
By: Kyle McEwan
Date: September 13, 2011
Steel is one of the most widely used metals in the industrial economy. Many industries including automotive, infrastructure, heavy machinery, pipelines, and shipping all use steel as its basic construction material. World economic growth tends to be highly correlated with the price of steel and as such its price provides an excellent benchmark for broad economic activity. In the past, copper has been the benchmark for global demand for raw materials around the globe and although it is still an excellent gauge, steel arguably has a broader role from an industrial perspective.
In 2009, the Chicago Mercantile Exchange launched a Hot Rolled Coil (HRC) Steel futures contract. The North American pricing benchmark for steel is the CRU (HRC) Steel Index and thus is the pricing benchmark for the futures contract. Producers use the CRU HRC Index to price floating rate steel purchase contracts and establish variable price delivery contracts for its customers. Given that the CRU HRC Steel futures are priced using the established industry benchmark, the futures contract is a fair instrument for hedgers as well speculators to participate in the steel market.
The HRC Steel futures are traded electronically through the Chicago Mercantile Exchange (CME) Globex platform. Contract Specifications are as follows:
Contract Size 20 short tons (Short Ton = 2000lbs)
Margin Requirement $880.00
Example
20 short tons * $735.00 price per ton = $14,700.00 Notional value of contract
The CME is expanding its products list for the commercial players in the steel industry via Clearport products such Iron Ore Average price options and Iron Ore CFR China Swap Futures. These contracts have yet to catch a significant amount of open interest with these products currently having 3705 contracts and 1020 contracts respectively. However, the slow start is not uncommon for newly established futures contracts.
When the London Metals Exchange (LME) launched the Aluminum contract in the 1970's, it took nearly a decade to get participation from all players, particularly the commercials. Large industry players are reluctant to fully adopt the futures contract as the tool of choice because they argue that introducing speculators would have a destructive effect on the market by increasing volatility of prices in an already highly cyclical industry. Producers want to prevent the price discovery process that comes with exchange traded products. If a producer can operate in a market with little transparency, it is better able to set prices for their customers. If a purchaser of steel is able to access better information, it increases competition and thus destroys profitability within the industry. The contract has also received push back from the providers of over the counter hedging services as they have a massive incentive to upset the progress of an exchange driven approach. Exchange based trading has a way of narrowing the bid/offer spreads and establishing market transparency that destroys the profit margins for over the counter market makers.
That being said all signs are pointing to a growing interest in the HRC Steel contract. This year there has been a fantastic increase in volumes for the HRC Steel contract. In the month of August the HRC futures contract volumes were up 228.2% year-over-year, according to the CME. The CME shows that open interest increased by 21.9% in August year-over-year to 11448 contracts from 9389 contracts. This data suggests that there is increase in the trading activity not just by current users but that there are a number of new participants entering this market. This is a very positive sign for the contract that more companies are beginning to utilize the derivatives market to manage their business.
Should this trend continue it is looking like 2011 could be the best year on record for the HRC contract and while we may not be at the major turning point for the HRC contract just yet, we are definitely getting much closer. With careful execution, adequate capital and patience, traders can use the CRU HRC Steel futures as a tool to participate in a market that broadly captures changes in global industrial demand.
If you would like to learn more about trading steel futures please feel free to give us a call at 416-862-3946 or send an email to kyle_mcewan@scotiamcleod.com . For other trading ideas please visit us at www.fennellthompson.ca.
Disclaimer: Opinions expressed are subject to change without notice. This report should not be construed as a request to engage in any transaction involving the purchase and sale of a futures contract and/or commodity options thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition.
