Cashing in

MINING EXPLAINED

—The following is an excerpt from Mining Explained published byThe Northern Miner.

As in any other industry, mineral producers have to find a market for their products. Only then can they profit from their efforts.

Some metals have an established terminal market — an institution where metal dealers bid for quantities of metal, and daily establish a price for it. Other metals are priced by individual producers, who respond to the market for the metal by raising the price in times of high demand, and lowering it when demand falls off.

For base metals, the most important international terminal market is the London Metal Exchange (LME) in London, U.K. The LME’s member firms specialize in metals-brokering services, facilitating the purchase and sale of metals to LME specifications by clients. Metals bought and sold at the exchange include copper, lead, zinc, aluminum, tin and nickel by way of twice-daily bidding rings. The LME functions as a clearing market for metals, offering both spot and futures contracts. Its primary role is to provide a service to clients seeking to fix prices, hedge inventories and generally manage risk from volatile commodity prices.

A buyer of futures purchases a contract for so many tonnes of metal, even though that metal has not yet been mined or processed. The contract specifies the metal will be delivered at some time in the future, usually in three months. The price offered will be different, and usually higher, than the spot price. Such futures and the warrants representing them are negotiable in the same way as spot metals.

The same reasoning underlies the trading of futures. That is, buyers seek protection against rising prices by hedging against current sales. Sellers of futures contracts, usually metal producers, ensure that their metal can be sold at the contract price, thereby “locking in” their profits.

Quotations from the LME are the basis for transaction prices in much of the world. The quotations represent actual day-to-day purchases between buyers and sellers, and they are released to news services and published in the daily press.

In North America, the Commodity Exchange (COMEX) in New York is a major terminal market in six metals. It tends to be a speculative market, attracting a much higher proportion of individual investors than does the LME. In London, the primary business is with trade accounts using terminal markets for business purposes.

Futures exchanges are basically hedge markets. A very small tonnage of the total sales on the hedge markets ever actually changes hands, physically. Most of the sales for physical supplies (metal producers selling to manufacturers of metal-based products) are handled by metal traders and/or producers. The merchant metal price generally fluctuates daily in line with movements on the LME and U.S. commodity exchanges.

The London Metal Exchange maintains a website with recent price and trading data, at www.lme.co.uk. COMEX prices are available at www.nymex.com.

Producers have a fixed price that is set periodically in response to prices on the terminal markets. These are called producer prices. It is also common for producers to sell their metal at a fixed premium to the daily settlement prices on the LME or COMEX.

Futures Dealing

In a normal market, the forward quotation is usually higher than the spot price. This is because securing copper today for delivery in three months requires someone to finance the copper. The cost of the forward quotation reflects this.

When the forward quotation is higher than the spot price, the market is said to be in contango. During periods of very high demand with very tight supplies, the spot quotation can rise above the forward quotation. This situation is called a backwardation. It signifies very high spot demand and the inability to supply it without offering a premium to draw it to the market.