The term base metal informally refers to a metal that oxidizes or corrodes relatively easily. These base metals are made up of copper, aluminum, lead, nickel, tin and zinc. The majority of these raw materials are brought to market via mining (recycle rates vary for each metal, but are still usually a minority source to mine production), and mining today is tougher than it has ever been. These metals can be traded on the LME (London Metals Exchange). The LME is the futures exchange with the world’s largest market in options and futures contracts on base and other metals. As the LME offers contracts with daily expiration dates up to three months from trade date, along with longer dated contracts, it also allows for cash trading. It offers hedging, worldwide reference pricing and the option of physical delivery to settle contracts.
The London Metal Market and Exchange Company were founded in 1877 but the market has origins going as far back as 1571 and the opening of the Royal Exchange. At first only copper was traded, lead and zinc were soon added but only gained official trading status in 1920. Other metals traded extended to include aluminum (1978), nickel (1979) and aluminum alloy (1992). The exchange also started trading plastics in 2005. Steel futures started trading in April 2008.
The critical function that the LME serves is one of physical storage of these base metals. The LME stockpiles the base metals to ensure price convergence and the ability to deliver the physical metal if a contract is redeemed. Since hedging and speculating are the most common forms of trading on commodities exchanges with only a small percentage of contracts ever resulting in delivery, the stockpiles offer more utility to those outside of the physical realm. Since most of the world’s base metals trade takes place directly between producers and consumers, the LME stockpiles are in essence emergency supply. When there is a global supply and demand imbalance, consumers are able draw upon the inventory that is stored in the hundreds of warehouses strategically located around the world.
LME stockpile levels fluctuate each day as there is constant inflow and outflow of inventory. But when outflow exceeds inflow for an extended period of time it can be inferred that consumers’ needs are not being met via regular supply channels. And inversely if inflow exceeds outflow for an extended period of time, it can be determined that the suppliers are producing the metals faster than they can be consumed.
These fluctuations of LME stockpile levels can help give you a good idea of the balance between global supply and demand. Many traders watch these fluctuations very carefully as they seem to strongly influence the pricing of the base metals.
Trading in futures and options involves a substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.
