Aristotle already knew about financial instruments

On the London Metal Exchange (LME) nickel prices over the course of last month were totally inconsistent. Initially there was a weaker phase due to an escalation of the trade war between USA and China, which pushed prices well below USD 11,000.00/mt, to the lowest levels seen this year. Because of pressure on prices and the general increase in uncertainty about global economic development, cut backs in stainless steel production had been seen for a while. After long term interest rates stopped rising, while short term interest rates increased (triggered by measures taken by the US Federal Reserve), a fear of a recession in the USA came up in the market. This type of inverted interest rate structure is still regarded as a relatively reliable indicator for a recession. On the other hand, reticence by the American Federal Reserve to further tighten monetary policy or even a generally better mood in the markets could also give reason for a turnaround.

On account of these somewhat reserved circumstances, intensified by the system of alloy surcharges, stainless steel trade is reducing warehouse stocks, which dampens any new demand. There is also a need to avoid a risk of devaluation, especially as yearend balance sheet day is approaching. The fact, however, remains that for 2019 there is expected to be a significant supply deficit again in nickel. Because of under-coverage in previous years, the extent of all nickel warehouse stocks has more normalised, quite apparent in the LME and SHFE (Shanghai Futures Exchange) warehouses.

Macquarie Bank expects inventories to cover a period of 11.1 weeks for 2019, and in 2020 to even fall to 9.7 weeks. In the commodity crisis year of 2015, nickel still had a range of 25.2 weeks, more than double what is now expected. Added to this, stainless steel production in China at the moment appears to be growing, unlike in Europe. It cannot be excluded that the generally lower stainless steel prices could make it more attractive for other uses. This substitution effect could increase stainless steel demand especially in Asia. So it is not surprising, that although most analysts have in the last few months corrected their price predictions to lower levels, their expectations are still clearly above present levels. Nickel prices are just not at a sustainable level.

Even on the LME nickel market for that matter, prices rise thankfully on any hint of improvement. Recently, what started as a rumour but then confirmed, an official statement about a renewal of talks between USA and China during the G20 summit in Brazil led to prices up to USD 11,400.00/mt once more. But then the arrest of the Huawei financial executive in Canada, at the request of the USA, soon undid the recovery.

All this shows just how much nickel prices are influenced at the moment by political and macro economical factors. Lower prices, however, have an immediate influence on stainless steel demand, incoming orders and then production. And these, in general, bearish sentiments naturally lead to investors and speculators on commodity markets to be more reticent, or even to sell positions in the short term creating a downward price trend.

Should the situation only slightly improve and politicians could, for once, find solutions to problems such as the trade war or Brexit, then prices could very quickly rise again, which in turn could lead to an increase in incoming orders and to a build-up of stocks, all giving a positive boost. But the timing for this to happen is not at all clear. Nevertheless, matters are closely interrelated and there are certainly signs of an economic slowdown but not of a global recession.

But sometimes an impression creeps in that one or more political decision makers would purposely trample on global economy just to prove their own power. Even China and also the USA, unlike Europe, could make use of existing financial leeway and other buffers as stimulus, compensating for the negative effects of the trade war. Of course, the best solution by far, and for all involved, would be a common settlement. The question then would be how to sell this as a success to their respective voting population after such an escalation and war of words.

A suitable protection against the present macroeconomic and political environment would be – if not already done – to decide on a hedging strategy and accordingly then put it into practice. However, a recently published report by a subsidiary of the management consulting firm Boston Consulting Group (BCG) shows that only a few companies from the DACH region (Germany D, Austria A, Switzerland CH) and from the United Kingdom do this. 88% of companies surveyed  expect a trade war. Indeed 93% of them expect rising commodity prices as a result of increasing protectionism. Only 23% recognise that financial instruments are suitable in hedging commodity purchases. So it is not at all surprising that 73% of those questioned hedge a maximum of 10% of their commodity needs by financial instruments.

In many cases, the explanation for a lack of hedging strategy was that they knew no suitable derivatives for the underlying commodity. A sign of insecurity: numerous commodities and currencies (including the helter-skelter digital Bitcoin) can be hedged on the exchanges. In addition, many executives consider hedging as to be speculative. The opposite is actually correct. An absence of a hedging strategy is speculative. After all, price movements of non-hedged commodities have a full impact on earnings. Furthermore, those surveyed named a lack of expertise about financial instruments in their companies as also a reason why commodity prices are not hedged.

The benefits of financial instruments were already recognised by the Greek philosopher Aristotle. In his work “Politics” which appeared in 332 BC, he discusses trading with options as exercised by the philosopher Thales of Miletus. By observing the stars and the weather, Thales concluded in one winter that the olive harvest would be particularly good for the following year. He then bought all the rights of use of olive presses in his region. The harvest was indeed a very good one which led to a strong demand for oil mills. Thales of Miletus sold expensive rights to use these. With his “oil press call option” he was able to recover his outlay manifold.

What can be considered as most welcome is the high regard in which steel and metal recycling is held by qualified representatives of the EU Commission. The phrase Urban Mining is now heard everywhere. Peter Handley, Head of Resource Efficiency and Raw Materials with the EU Commission, clearly pointed out at the Raw Material Week, which was organised by the EU, that steel recycling, as well as conserving primary resources, also saves considerable amounts of energy with big reductions in emissions. Urban Mining is therefore an indispensible part of the Circular Economy Strategy formulated in 2015 by the EU Commission. But there are still many challenges. Especially the fact that products and their composite materials are becoming more and more complex, which does not make their recycling any easier. Therefore it should already be mandatory that when developing innovative materials and products, the ability to recycle at the end of a product’s life cycle should be considered. Unfortunately this is all too seldom the case.

Music knows no boundaries. The Düsseldorf artist Björn Frahm is looking for young motivated artists for a music project. On the occasion of 250th Anniversary of the birth of Beethoven, Frahm, under his artistic pseudonym “Freeze 4U”, would like to perform the Ninth Symphony on pieces of scrap. With this extraordinary project, he wants to introduce young people to new horizons in classical music. At the same time, by performing the music on scrap parts, an acknowledgement is made to its sustainability. Of course, the instruments will be self-made and tuned. The result can be heard by music enthusiasts in a concert to be held in December 2019. Additionally, flash mobs and a radio performance are in the planning. The artist has been well-known for a number of years now. He did once form a band where all members had one thing in common: They all came as refugees to Germany.

Finally we would like to recommend to all our readers the “Hand Book of Alloyed Steel Scrap”, which has just been published by the German Steel Scrap Association (BDSV). It can be used both as a quick reference guide or as a more in-depth read: Suitable for the office desk or in the warehouse or in production. The publication gives a sufficiently deep overview and insight into the world of alloyed steels and scrap. Terminology and definitions of alloyed scrap are also part of the contents, as well as an overview of the whole spectrum of stainless steels. There are also special mentions made to the more seldom qualities such as tool and high speed steel, the super and special alloys such as Titanium and other (pure) metal scrap. The book can be ordered from the BDSV at a cost of EUR 18.80.

To all our readers, we wish you and your families a Merry Christmas and the best of success in the coming year.