16 octubre 2006

The Metals Bull: Powered by Hedge Fund Speculators or Lessening Supply?

Muy buen comentario sobre la importancia real que tienen los hedge funds en los precios de las materias primas:

I won’t attempt to dispute the inflationary effect that leveraged instruments such as derivatives can have on their underlying asset. What I will dispute is the large premium that commentators assign to them and to prove it I will turn to the iridium market.

What is iridium you ask? It is a member of the platinum group of metals alongside palladium, platinum, ruthenium, rhodium and osmium. It is a very hard but brittle metal making it hard to work with but it is also the most corrosion-resistant metal know to man. Applications of iridium range from tipping fountain pen nibs to making devices that are required to withstand high temperatures. Only about three tones of this substance are mined each year mainly as a by-product of nickel. The current price is $400 per troy ounce.

Now the main point is that iridium is not traded on the futures and options markets. The main refiners such as Engelhard and Johnson-Matthey set a base price to which dealers then add their bid-ask spread and produce it. Distributors then sell it on in powder, foil, wire or tube form to industry.

In that respect, it is difficult for an investor to take possession of this metal for speculative purposes. They can’t pay a small amount to lay claim to a 400-ounce contract or anything like that. They basically have to buy it wholesale cash up front and also come up against an industry that may not take kindly to new fangled interlopers. However, if you really want to buy this stuff, the determined investor will find a way. In fact, you can buy iridium by the gram on eBay and will cost you $653 per troy ounce or 63% over spot.

So this metal cannot be said to be the plaything of hedge funds or even small speculators. In that light, how has its price performed in this metals bull market? Has it failed to live with its big brothers, Platinum and Palladium, which enjoy derivative status? Not at all!

If we compare the two from 2001 onwards when the bull market began to wake up, we see full participation in the boom by iridium. From individual lows in mid-2001, platinum advanced 116% while iridium flew from $100 to $400 or a 300% gain. This is a gain comparable to the moves seen in silver, copper and so on. One may even note the correlation in dips as both metals took a rest in mid-2002 before taking off again early 2003.

No doubt about it, in the absence of leveraged paper contracts, iridium proves that the gains seen in the metals market are real and can only be partly explained by speculative interests.

So where does iridium stand today as our bellwether of real commodity demand pricing? The answer is flat as a pancake. The price has stayed fixed at $400 since the time other metals took a dive. This however raises a question. Why has iridium flatlined while other metals have dropped something like 25% during that time?

The answer lies not in derivatives adding a huge price premium across the entire six year bull market but rather because they add a short-term volatility premium at points of consolidation.