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Hedging

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by - 6/22/2009 7525 Views

Protection and Reward

Ignoring storage, insurance and finance costs AUD 1,000 invested in the following metals on 1st July 2008, on 11th June 2009 would be worth:

Aluminium – AUD 627.68

Copper – AUD 709.87

Lead – AUD 1232.37

Zinc – AUD 1047.15

On the other hand AUD 1,000 invested in the same metals on 11th June 2009 will be worth in one year:

Aluminium – AUD 1,127.60

Copper – AUD 1,035.70

Lead – AUD 1003.91

Zinc – AUD 1106.70

Guaranteed – no baloney!

How?

The return is generated by selling the metal forward using futures contracts and hedging the currency risk for one year.

Any recycler with price risk relating to stock levels can generate additional returns by hedging the underlying risk to the price of the metal quoted on the LME.

Over the last 12 months commodity markets suffered the extreme price volatility as demand waxed and waned in accordance with the trends in global economic conditions. Significant losses were incurred by scrap metal recyclers around the world as unhedged stocks plummeted in value. If these risks had been covered buyers could have held on the stock until demand picked up and in the meantime generated an additional return.

The hedge generates additional income while protecting the downside. This stems from extracting the price differentials between the spot and forward prices of metals, contango. Where metal is bought in local currency there is also an adjustment to cover forward foreign exchange risks. The difference between AUD and USD works in favour of the hedger generating further returns.

While combining a hedge policy with prudent guidelines for managing metals prices, the company can more reliably gain from managing the risks rather than ignoring them.

Category : General

Tags : General Scrap, Metal Scrap,


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About Tony

Thirty years experience managing financial risks in companies and banks on four continents.

Using this experience and inside knowledge gained spending a year with a large Australian metal recycler devised strategies to overcome various pricing .... more info

Comments


 
Scrap hedge

but what about a billet plant that use metal scrap as a raw material do they have options ? the contracts are not liquid enuf its more likely  have to be a cross commodity hedge using diffrent metal.  neither is LME Billet price in line to the Domestic markets nor is the scrap pricing