Magazine article Modern Trader

Steel Futures: Ready for Prime Time?

Magazine article Modern Trader

Steel Futures: Ready for Prime Time?

Article excerpt


Steel futures and options may be coming your way - like it or not. Here's where they fit into the metals market landscape.

This is the year that steel futures and options came of age. Both the London Metal Exchange (LME) and CME Group (Nymex) are expanding their metal operations with respect to steel futures, although progress toward global pricing and trading of steel futures UMS made first bv LME.

Before the initiation of steel futures trading tiy LME in 2008, a futures market in steel was not without controversy. Many producers would prefer to stay with the traditional negotiated contracts for pricing their products. The fear expressed by some producers and users of steel is that futures trading attracts too much speculation - more than the amount needed to offset normal hedging risk and enough to cause disruptive price movements.

During the spring and summer of 2010, LME continued to announce increased volume of trading in steel futures contracts. For example, volume for the month of July was 18,906 lots traded of the steel billet contract, covering 1,228,890 metric tons, and this was the fifth consecutive month of record volume. Although the steel futures market is still young, it is developing a sustainable growth rate even in this period of worldwide economic contraction.

Steel futures trading in the United States should expand further as the result of two recent initiatives by LME: the change from trading two contracts, Mediterranean and Far East, to a single global steel futures price that merges the two previous contracts, and the establishment of delivery points at New Orleans, Chicago and Detroit.

Over the past five years, six exchanges have begun trading steel futures based on a variety of produces. The following list shows the exchange locations and the steel products covered by futures contracts:

* London (LME): rebar quality square billet, 65 metric tons per contract

* Dubai Gold and Commodities Exchange: rebar, 10 metric tons

* CME Group (Nymex): U.S. Midwest hot rolled coil (HRC), 20 short tons

* Shanghai Futures Exchange: sceel wire rod and rebar contracts, each 10 metric tons

* India (National Commodity & Derivatives Exchange): mild steel ingots, mild steel billets, each unit equal to 10 metric tons

* India (Multi Commodity Exchange of India): steel flat, 25 metric tons, and steel long, 15 metric tons

Most steel futures contracts are physical iy deliverable to one of multiple locations in the various countries in which they are traded; however, CME Group's steel futures are settled in cash against a reference price for U.S. Midwest hot rolled coil. Convenience for steel buyers and sellers was an important consideration in the recent establishment by LME of a delivery location in New Orleans. In any case, steel for trading or delivery on the exchanges listed above must meet quality standards (for example, steel originating at an exchangeapproved producer).

"London steel" (left) shows daily averages between buyer and seller for Mediterranean and Far East contracts. Increased volatility is obvious for both contracts in March and April 2010, with prices declining with a slower economy and falling demand for steel products toward the spring and summer. From January through mid-Ma}', the Mediterranean price changes lead the Far East futures. From later in May through June, the two prices are identical as the market prices anticipate the origination by LME of a single global steel futures price on JuU1 28, 2010.

On "Dueling metals" (right) the three series of daily prices are shown as ratios to their average price over the period Feb. 1 to Aug. 31, 2010. The higher volatility of steel futures (using only the Mediterranean contraer) reflects the peak and decline shown i n the " London steel" chart. Copper futures exhibit a smaller amount of volatility, although they match the steel price increase and subsequent decline through March and April, in timing if not in absolute gain in the price ratio. …

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