How Are Prices Determined In Metal Markets?
Metal prices are not only important to manufacturers and end-users but have long been used as a tool for monitoring economic and market conditions. But how do markets determine metal prices?
Metal Market Information
The prices of individual metals, like prices for any commodity, are essentially determined by supply and demand. However, to assume that information on supply (production and inventories) and demand (consumption) is readily available, accurate and transparent, would be a big mistake, regardless of the type of metal.
Current prices do not only factor in immediate supply and demand but also expectations of future supply and demand. In general, the less information available, the greater price volatility will be.
A large service industry has grown around researching, reporting and consulting on virtually every individual metal. Countless websites now report on the movement of metal prices.
Of course, the majority of this research and reporting is focused on the large base metal markets, such as copper, nickel, zinc, and lead. But, in recent years, more attention has been given to minor metals, including rare earth elements.
Price determination mechanisms range from an advanced spot and forward contracts traded online as well as in London at the London Metal Exchange (LME) or in New York at the New York Mercantile Commodity Exchange (COMEX) to basic cash exchanges between buyers and sellers.
A more mature metal market, such as that for nickel ingots, is characterized by more transparent price determination methods, such as the open-outcry system of floor trading at the LME, as well as option and forward contracts that reflect what market participants expect nickel metal prices to be 30 to 120 days in the future.
By storing and publishing data on nickel—as well as other base metal—inventories, the LME also provides some degree of risk reduction for buyers and investors.
Statistics on global tellurium metal production, in contrast, are not only difficult to come by but are unreliable, to say the least. One major reason for this is that it is not in the interest of refiners—which are often privately held companies—to publish information on production and inventory levels.
The demand markets for tellurium—and most minor metals—is not much more predictable, being dependent on only a few applications, such as solar energy and thermo-electronics. The total quantity of global tellurium production also limits the possibility of exchanges from managing transactions or the development of electronic trading and forward contracts. As a result, buyers and sellers of this minor metal must negotiate cash purchases of the physical metal.
Classifying Metal Markets
Due to differences in market structures, price recognition methods, as well as quantities produced, metal markets are often separated into five groups, each with distinct characteristics:
The global market for base metals can be considered the most developed of any group of metals. In fact, forward contracts for deliveries of copper and tin date back to the 19th century. Now markets with trading desks around the world settle transactions, equaling trillions of dollars each year.
Forward and option contracts, as well as electronic trading, have all contributed to a more efficient market. That is one that can more effectively determine what buyers and sellers are willing to pay for a particular metal. Consequently, the difference between bid and offer prices for standard base metals is normally much smaller than what one would see for other metals.
Downstream metal prices, such as copper wire or powder, as well as upstream raw materials, such as copper ore and concentrate, can be bought and sold based on prices determined by the market standard.
Steel and Ferro-Alloys
Although well established, the market for steel is not as mature as the market for base metals. This is primarily because steel, by nature, is a less tradable commodity. The wide range of grades and variance in forms, which are required by countless end-users, make it difficult to establish a market standard in the way that copper cathode, for example, is standardized.
Nevertheless, the LME began offering contracts based on 9 different grades of steel billets in 2008. The New York Mercantile Commodity Exchange (COMEX) began trading hot-rolled coil futures the same year, while the Shanghai Futures Exchange began trading futures of Chinese rebar and wire in 2009.
The market for ferroalloys, such as ferromanganese and ferrosilicon, is less mature, with prices often being determined directly between buyers and sellers.
Prices for minor metals, including electronic metals such as indium, gallium and germanium, and refractory metals like tungsten and tantalum, are almost exclusively negotiated between buyers and sellers. The low number of market participants, as well as the evolving applications for many of minor metals, makes it difficult to develop more advanced investment and price determination tools.
In 2008, however, both cobalt and molybdenum metal contracts began trading on the LME, making them the first minor metals to have forward markets. The transparency provided by electronic and floor trading, as well as established inventories, in theory, reduce price volatility and provides more accurate price realization.
Platinum Group Metals (PGMs)
Due to the extremely limited number of PGM refiners and suppliers, prices for these metals are traditionally set by the sales offices of major producers. Johnson Matthey, the exclusive marketing agent for Anglo Platinum (the world's largest platinum producer), sets wholesale prices for each of the PGMs twice daily at its trading desks in the USA, Hong Kong, and London.
Prices for some metals, such as osmium, have seen little change in years, mostly due to limited use, whereas prices for platinum, which has significant demand from both industry and investors, fluctuates daily.
Excluding platinum, palladium, and other PGMs, when we speak of precious metals we are discussing gold and silver. For thousands of years, both metals have been used as a store of wealth and, not surprisingly, both have well established and transparent markets.
The London Bullion Market Association (LBMA) has operated since 1919 and is the most common benchmark for the price of gold, while gold futures are traded on COMEX and Euronext. Various other financial and investment companies offer derivatives, options, futures, and exchange-traded funds based on the market price of gold.
Although the LBMA and COMEX also offer various forward market contracts for silver bullion, prices for the metal are generally considered more volatile than gold prices. This is due to its slightly lower liquidity (fewer buyers and sellers) and the influence of industrial demand for silver, which has grown to account for about 90% of silver demand annually.
Metal Market Prices vs. Metal Product Prices
While economist, analysts, and journalists are generally more concerned with macro-market prices for large quantities of industrial or investment grade metals, manufacturers and end-users require prices specific to a particular grade, form, and quantity of metal.
What this means is that, while economists may study the London Metal Exchange (LME) price of copper cathode, construction companies, and electronics manufacturers are basing their budgets on the price of copper wiring and copper powder.
Without question, a direct correlation exists between tradable industrial metal prices and downstream metal material prices, but the two are never the same (much like the price of flour may influence, but does not determine, the cost of bread). The farther down the value-added stream one goes, the more factors (e.g labor, energy and transport costs) begin to influence metal product prices.