They Have Arrived (Metal ETF’s that is)

Implications: While reviewing the performance of resource funds for the first quarter of 2008,  I realized that there is now an availability of buying or selling specific commodities for actual users as a 'hedge' against price volatility.

Analysis:

They Have Arrived (Metal ETF’s that is)

 

In the past, speculators were most likely to purchase or sell futures or options listed on commodity exchanges. New commodity funds have recently emerged that allow speculators to participate in specific materials such as copper and nickel by trading an ETF (Electronically Traded Fund). These transactions are treated the same as a stock.

 

But, these new trading vehicles now make it simpler for actual buyers and sellers to ‘hedge’ the market to minimize price volatility. I recommend to all my suppliers and customers that handle copper and nickel based products to look into these ETF’s:

 

iPath DJ AIG Copper Total Return Sub Index:   symbol JJC

iPath DJ AIG Nickel Total Return Sub Index:   symbol JJN

 

The simplicity and minimal cost of trading these shares lend themselves to a huge increase in awareness and usage. If you have an online account, you can buy or sell each transaction for under $10.

 

One way to hedge the market is to calculate the element value of the material you want to hedge. For example, if you purchased 100 ton of 18/8 stainless steel for a future delivery, you would have 100 ton X 8% Ni X 2000 lbs/ton or 16,000 lbs of nickel unpriced. In order to hedge the nickel market against an increase in price at the time of delivery, you would need to purchase an appropriate number of shares. On April 25, 2008, the JJN price was $45.84 and the LME Nickel price was $13.11. The appropriate number of shares would be 16,000 X $13.11/$45.84 = 4576. These 4576 shares represent $209,764 of nickel. In this example, there is not a hedge for the chrome or iron values, or any other value added charges.

 

Another example is if you sold 20 ton of unpriced 70/30 brass scrap, you could hedge the copper value of the brass by selling the appropriate number of shares of JJC. In this example, 20 ton X 70% X 2000 lbs/ton leaves you with 28000 lbs of copper exposure. On April 25, 2008, the JJC price was $55.00 and the LME Copper price was $3.90. The appropriate number of shares would be 28,000 X $3.90/$55.00 = 1985. These 1985 shares represent $109,175 of copper.

 

Of course, once the actual sale price is fixed, you must buy back or sell the shares to remove the hedged position.

 

The hedge works this way. Should the value of nickel (or copper) increase or decrease the iPath would increase or decrease by the same approximate percentage. Any loss in the iPath would be offset by a gain or savings in the actual physical sale of those elements, and vice-versa.

 

The only negative I see to participating in these ETF’s is that you may have to fund your account. If you define it as a hedging account the percentage of funding used to be lower than a regular margin account. Check this out with the broker. However, if this is not a problem, I recommend you set up an account with your favorite online broker, or even an offline broker for a slightly higher fee.