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The LME has announced plans to launch physically delivered cobalt and molybdenum futures contracts in response to strong demand from industry for reliable prices and better risk management mechanisms.
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Cobalt and molybdenum contracts will enable industry to hedge against volatility in prices. Hedging is the process of managing the risk of a price change by offsetting it in the futures market. The ability to hedge gives producers, consumers and merchants in the industry the choice of how much price risk they are prepared to accept. The process of hedging will also create for the first time a truly transparent and representative market price.
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Molybdenum production is around 190,000 tonnes a year, with a value of $14 billion, while cobalt weighs in at 55,000 tonnes and around $4 billion. That compares with tin’s 350,000 tonnes ($6.3 billion).
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Trading is out to 15 months on the Ring, Select and telephone. As with all other LME contracts, only members of the Exchange are able to trade; the physical industry and other market participants must access the market and its risk management services through the LME’s membership.
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The option of physical delivery, whilst very rarely used, plays an important role in creating LME price convergence. In effect this means that if the LME price appears too high or too low, those in the market will see favourable pricing opportunity and make use of the delivery mechanism. This presence, or threat, of delivery has the result of constantly ensuring that the LME price is in line with the physical market price.It also enables industry to sell material via the Exchange delivery system in times of over supply, and use the LME as a source of material in times of extreme shortage.
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The LME is primarily a financial, rather than a physical market, where trading is used to manage risks rather than secure metal. Less than 1 percent of contracts traded on the LME result in physical delivery, so the chances of being stuck with metal you cannot use are very low. In the unlikely event that a contract goes to physical settlement, lots can be swapped or sold at a premium or discount to the LME price. The cobalt industry is already used to this way of doing business, as it already trades metal at a premium or discount to the Metal Bulletin cobalt price.
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Futures contracts have provide effective and reliable tools with which to manage volatility.
Cobalt and molybdenum are already volatile markets, but the LME contracts will help industry manage risk much better.
The introduction of a futures market introduces the potential of funds and speculators to invest in the industry; their involvement does not increase fundamental volatility and may dampen cycles by taking the opposite side to industrial clients.
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Speculators are already involved in cobalt and molybdenum and contribute to volatility. Metals traded on exchanges are often less volatile because more participants have access to the market and their actions are regulated.
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