Thread on Curve Structure for LME Metals

This is complicated, so do feel free to tweet any questions!

First up some terms:
Contango: when the forward price is above the current spot price
Backwardation: when the forward price is below the current spot price
When a market is well supplied or in surplus it tends to be in contango. The normal state of metal markets is to be in contango from the cash date, but with the contango becoming less as you go further forward.
This is because there is a limit to how big this contango can be as otherwise there would be an arbitrage in buying metal today, storing it, and then selling it at a future date at a profit. This concept is called “full finance contango”.
Full finance contango is the cost of money, insurance, and the cost of warehousing. So for example:
Copper price = $10,0000
Risk free rate = 1%
Insurance = $0.05 per day
Warehousing = $0.75 per day
1 year full finance contango = 10,000 x 1% + 365 x (0.05 + 0.75) = $392 per year
In practice you will never see full finance contango for more than a few days beyond the spot date. If you could borrow for a whole year, you could hedge all of your risks and be left with a free option on the price curve tightening to less than full finance contango.
One of the consequences is that it can pay to be short in a contango market. You do have the price risk of the price going up, but it is skewed in your favour for a 4% yield in the above example.
A lot of market professionals will run shot positions to tom-next and borrow every day at full finance contango. This is likened to picking up pennies in front of a steamroller because you only need one day when tom-next trades at a big back to lose weeks or months of profits.
When a market is in deficit it will probably still trade in a contango if there is sufficient inventory in LME warehouse. This metal’s ownership still has to be financed, and the warrant holder will often enter into an agreement with a bank to provide the finance.
This gives the holder flexibility on when to consume or sell the metal.
Only when a market is in deficit and inventories are low do you usually see backwardations. We are seeing some pretty extreme backs in #tin right now as there is simultaneously a large deficit and very little inventory.
What a large backwardation does is encourage consumers to defer consumption. So for example if cash tin today is at $39,000 but 3m tin is at $35,000 then I could close my factory, deliver the tin that I have bought from a smelter into a LME warehouse and “earn” $4,000.
This is an extreme example, but at the margin backwardations discourage immediate consumption and help to balance the physical market.
Although a forward curve does give a price for any date out into the future, it is not a predictor of where the price will be on that future date. It is however the best guess of where the price will be on that date.
The forward price is better thought of as a function of the price today, the cost of money and warehousing, and the propensity of consumers to defer consumption to a later date.

• • •

Missing some Tweet in this thread? You can try to force a refresh

Keep Current with Mark Thompson

Mark Thompson Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!


Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @METhompson72

14 Oct
Everything that is happening to the #tin price would have happened 8 years ago if Myanmar had not come along and gone from 2kt to 60kt of production overnight.
Market demand is 30% higher today, and Myanmar production in terminal decline as all the rich pickings are depleted.
Who can fill This void in the short or medium term? Only artisanal producers in DRC and Indonesia - but little sign of that at the moment.
Long term we need new, large hard rock mines. But there are very few known assets that can add more than one or two thousand tonnes of supply
Read 4 tweets
20 May
#copper $MNO.v
So a quick thread on why VMS type copper deposits are so much more valuable than porphyries.
(I am talking in the generic here, and each project has its own specifics so please do not message me saying I am wrong about such and such project!)
VMS = Volcanogenic Massive Sulphide are “black smokers” emplaced on the sea floor and then moved to surface via tectonic activity. They are almost always polymetallic and contain copper, zinc, gold, silver, zinc and lead.
VMS’s are found around plate boundaries and usually occur in clusters – or “camps” – such as Flin Flon, Bathurst or Noranda. Tonnages typically range form a few million tonnes of ore to +100Mt. Copper equivalent grades are typically 1.5% ish.
Read 13 tweets
10 May
#copper #tin
This thread will talk about the huge issues facing consumers from a finance perspective. This is a bigger problem than availability of metal or the price being paid.
Exponential price rises are creating huge headaches for consumers - both in terms of price paid, availability of metal and in finance. Of these finance is probably the biggest issue.
Metal supply chains have multiple points: from metal to shapes to intermediate products to final products. For example for copper consumption in an A/C unit it goes from cathode to plate and wire rod, to tube and wire, to heat exchanger and copper flex. Then final product.
Read 9 tweets
10 May
#mining #copper #tin
I have been asked by several people now about how to evaluate the management team for a project and what to look for and what to avoid. This thread hopefully will provide some good pointers.
Truth Number One:
A mediocre project with good management is a better investment than a great project with mediocre management.
Truth Number Two:
There is no such thing as a bad project with good management: good people just don't get involved with bad projects.
Read 12 tweets
3 May
“The world’s top copper producer Chile saw output of the red metal fall for the tenth consecutive month in March, government statistics agency INE said on Friday.
Copper output fell 1.3% in March, to 491,720 tonnes, the agency said.”
Chile also introducing new restrictions on movement and commerce following the Southern Hemisphere’s summer holidays. I expect their already bad Covid situation to get worse as they move into their Winter / European Summer.
As I understand it most mines have had essential workers only on site - very few contractors allowed in. This means essential specialist work and maintenance has not been kept up to date with operating and mining plans.
Read 5 tweets
26 Apr
The global zinc market is, give or take, 13 million tonnes. China is far and away the largest producer with over a third of mine production and smelter capacity. Supply growth in China is static though with new mines barely replacing old mine capacity.
Zinc’s main use is as a anti-corrosion coating on steel in the construction and automotive industries. This is called galvanization. Other uses include alloy (brass mainly) die-casting precision components and as a fertiliser additive.
Consumption growth is highly correlated to Global economic growth - 2.5x geared to growth above/below 2.5%. (i.e. zero consumption growth at 2.5%, but 5% consumption GDP growth of 4.5%.)
Read 15 tweets

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!

Follow Us on Twitter!