Industrial metals can offer some compelling trading opportunities, especially as at times they tend to be subject to very sharp changes in price.
Investors can position themselves to take advantage of such movement through trading in futures, options, Contracts for Differences (CFDs) or ETFs on the underlying metals as well as by taking positions on the shares of mining and metals companies.
Supply and demand
Industrial metals are used in a range of ways, predominantly in the construction and manufacturing sectors.
The most widely used industrial metals are steel, aluminium, copper, lead, tin, nickel and zinc. However, with the rise of the electric car industry and increased demand for rechargeable batteries metals such as cobalt are becoming more sought after as well.
Industrial metals prices today are mainly influenced by supply and demand, with prices tending to rise when economic activity increases and fall when it contracts.
By the same token, current prices of industrial metals are also heavily influenced by future expectations surrounding supply and demand.
Supply can lag
Higher demand drives prices up, but supply is also critical as a favourable impact from rising demand could theoretically be totally offset by increased supply.
In practice though, there can be a considerable lag before increased supply comes on stream to cater for higher demand.
When the global economy slumps, smaller miners and producers can find the lower prices that result uneconomic, resulting in numerous shut downs.
It means that when the global economy finally improves and prices begin to rise once more, there might be considerably less available supply. Higher demand combined with more constrained supply can make prices jump sharply.
Eventually, once more supply comes on stream, prices can become especially sensitive to any fresh economic downturn. More abundant supply combined with a fall in demand may bring abrupt falls in prices. The cycle tends to repeat itself.
The London Metal Exchange (LME) has long been the leader in industrial metals trading.
Theoretically, exchange traded metals, with the benefit of electronic and floor trading, are characterised by lower volatility and more accurate metal market prices compared with metals traded outside formal exchanges.
The LME is an oft-cited source for both spot prices and forward prices.
While the LME was originally set up for the trading of non-ferrous metals (those not containing iron), these days it also offers contracts in the ferrous category.
Today, along with the base metals, namely copper, nickel, zinc and lead, LME also facilitates trading in aluminium, steel and in minor metals such as molybdenum and cobalt.
Of the various categories of metals within the industrial complex, most research and data are focused on the large base metal markets (copper, nickel, zinc and lead).
The base metals market is the most developed, distinguished by huge trading volumes, electronic trading and widespread derivatives contracts that serve to boost market efficiency.
As a result, the difference between bid and offer prices for base metals tends to be considerably smaller than for other industrial metals.
Evolving needs of industry however, including the rise of smartphones and more latterly electric cars, means there is growing activity around some of the less well-known metals.
For instance, cobalt and molybdenum metal contracts were added to the LME as recently as 2008.
The LME also began offering contracts in steel during the same year, a move that was closely followed by some other competing exchanges around the world.
Steel has traditionally been viewed as less tradeable by investors compared with many other metals, being less standardised due to the wide range of different grades available.
Matal market prices discovery
Industrial metals traded on the LME are priced per tonne and in US dollars.
Options and futures contracts are available on LME metals, potentially enabling investors to profit from rises and falls in the underlying prices, as well as facilitating more efficient price discovery and liquidity in the metals market.
Investors use the contracts available through the exchange to either take speculative positions on future price changes or to hedge their existing exposures in metals.
As well as facilitating the trading of metals derivatives as an exchange and providing price data, the LME is also a physical market for the consumers and producers of the metals.
Changes in the physical metals inventories of the LME are an important gauge of the state of the global metals market.
Falling inventories may indicate rising demand for a given metal as participants buy up supplies in reaction to emerging shortages in the market.
Rising inventories could be indicative of the reverse scenario, and potentially a sign of oversupply.
While LME faces competition from the COMEX division of the New York Mercantile exchange, the industrial metals traded on this latter are limited to aluminium, copper, zinc and lead.
In contrast to the LME, where prices are quoted in tonnes, COMEX prices are quoted in pounds. Just like LME, COMEX offers a variety of derivatives contracts.
Increasingly, the Shanghai Metal Exchange (SHME) is also viewed as an important competitor to the LME.
In some ways, SHME complements the LME however; by operating on a different time zone, it enables investors to carry on trading in certain metals when the LME is closed.
SHME offers contracts on copper, steel, aluminium, zinc, lead, tin and nickel.
While the globalisation and broadening of the contracts available for investors to trade across the various exchanges results in more opportunities, it also means there is more information on the market for investors to process.
For instance, inventory data in China is becoming an important gauge of the market, just as the LME inventory data has always been.
Its wide variety of applications and versatility means copper tends to be highly sensitive to economic cycles with prices rising/falling as the global economic accelerates/slows.
Viewed as a good conductor of heat and electricity, it is heavily used in the building industry.
As well as its direct applications, copper has long been used to make alloys, such as brass, sterling silver and cupronickel.
More recently, copper has also caught investors’ attention for its usefulness in the fast-growing electric car industry. This has been partly responsible for a 20% year-to-date (2017) rise in copper prices.
Most copper is mined in Latin America, with Chile as the world’s leading producer. Just a small fraction of the world’s copper reserves is economically viable to mine.
On some estimates the world could run out of mineable copper in as little as 25 years. On the flip side, however, it’s also one of the most recycled metals; as a result, some 80% of all copper ever mined is thought to be still in use.
Copper futures have long been traded on the London Metal Exchange (LME) and are also available on the New York Mercantile Exchange (NYMEX).
Like copper, Aluminium is a good conductor of electricity and heat. However, in the case of the latter, its central characteristic of being both strong and lightweight has been a main driver of its widespread applications.
Aluminium leads the way among metals in terms of its variety of uses. Its favourable strength-to-weight ratio means aluminium is fast becoming the metal of choice in transportation, taking over the role of steel.
Its non-corrosive nature gives aluminium another natural advantage, removing the need for high-cost anti-corrosion treatments.
The drive for fuel efficiency, especially with the rapid take-up of electric cars, means that aluminium is on course to comprise 60% of all cars within the next 10 years, compared with 40% at present.
Its malleable nature, resistance to corrosion and high strength-to-weight ratio, means aluminium has also become popular in the construction sector. In addition, aluminium’s shiny appearance has made it suitable for use in consumer goods such as televisions and smartphones.
Rising demand has seen aluminium prices rise by 21% over the past year. However, production is likely to come up against overcapacity issues in the future, as it has done in the past, as Chinese smelters raise output to meet demand.
Aluminium is made from bauxite, a relatively abundant ore, with Australia, Brazil and China among the top producers.
As the extraction process from bauxite uses electrolysis, recycling aluminium can be much more economic, cutting down on electricity bills.
Recycling rates have reached up to 95% in the building and transport sectors. While rates vary around the world, the percentage of aluminium cans being recycled is converging around the 70% mark in both the US and the EU.
Aluminium futures are traded on the LME, NYMEX and Tokyo Commodity Exchange (TOCOM).
Zinc has long been used in combination with copper to form brass, an alloy that is favoured for its resistance to corrosion and gold-like appearance, making it ideal for such things as door knobs and locks.
However, the major application of zinc today is as a corrosive-resistant coating for steel, making zinc prices sensitive to cyclical steel demand.
To a much lesser degree, Zinc can also be used as an ingredient in electrical batteries. So-called Zinc-air rechargeable batteries for electric vehicles are less common than other battery types, such as lead-acid or nickel-metal hydride.
The relatively abundant reserves of zinc across the world (up to 2.8bn tonnes) means there is arguable scope for it to become more widely used in electric car batteries in the future.
At the same time, much of these reserves are not necessarily economically viable to mine at present, and on this basis the world could run out of economic supplies of zinc by as early as 2030.
Making such forecasts difficult, however, is the large rate of zinc recycling, currently put at around 80% in certain developed countries.
China, Peru and Australia are the leading producers of zinc, with the latter two among the key exporters.
China tends to be a big consumer of zinc, with demand having risen to satisfy the needs of big Chinese infrastructure projects. The latter has helped drive a 30% rise in zinc prices over the past year.
Most trading in zinc futures takes place through the LME.
The most common use of nickel (around 70% of output) is as an input in the production of stainless steel, a corrosive-resistant form of steel that is widely seen around the home.
Stainless steel also has widespread use across industry, from medical instruments to subsea pipelines in the oil & gas sector.
Although accounting for a relatively small proportion of nickel demand at present, it is also increasingly used in batteries for the fast-growing electric vehicle industry.
Most nickel reserves are found in Australia and New Caledonia, though both currently lag the Philippines, Russia and Canada, which are currently the world’s largest producers.
Prices are up by around 10% over the past year, having rallied strongly in the middle of 2017 amid strong demand from top consumer China on the back of robust stainless-steel production.
The market has also been supported by hopes of rising demand for nickel on the back of the rapid growth being seen in the electric car industry.
Over recent weeks, nickel prices have given back some of their earlier gains, with measures by the Chinese authorities to clamp down on production over the winter months set to curtail steel production.
Nickel futures are primarily traded on the LME.
Lead’s properties as a shield against radioactive substances is well known.
The Romans used lead in piping for their water supply, which proved to be not such a good idea given the metal’s toxicity for humans. Europeans had still not learnt their lesson by the 18th century, when the widespread use of lead in makeup resulted in a high incidence of poisoning.
Today, lead’s primary use is in the manufacture of batteries, which account for 80% of global demand, though it still continues to be widely used in the building industry to prevent water penetration in roofing and cladding.