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“Hedging is very important as sharp fluctuations in spot prices can happen outside of the more normal market forces of supply and demand,” GFI Group steel derivatives broker Henry Herbert said.
Unpredictable events such as the introduction of new import tariffs and political instability can affect both prices as well as currencies, as demonstrated by recent events such as the United States’ Section 232 and 301 investigations on steel and aluminium imports, as well as snap elections in Turkey, he added.
Unpredictable events Market sources have told Metal Bulletin that the ongoing trade squabble between the US and China, including the tit-for-tat imposition of anti-dumping duties and blanket tariffs on steel products, was a major cause for concern due to their immediate impact on spot prices.
Government policy is especially hard to anticipate and it can have a huge effect on the price of steel, especially in the current political-economic climate, according to risk consultancy Ferrometrics’ chief executive Phillip Price.
“It’s more important than ever to identify the most suitable tools and strategies to mitigate price risk and consider the potential impact of government policy on basis risk,” he said.
This is especially so for products that see the largest trading volumes in Asia, including hot-rolled coil, rebar and billet, of which key producer China plays a major role.
“Derivatives [that] are based off fob China HRC and rebar indices will help reduce basis risk for traders whose physical exposure is closely linked to that steel product and that location,” GFI Group broker John Wright said.
Indices for hedging Metal Bulletin launched daily fob China indices for HRC and rebar because of the huge trading liquidity in the physical markets for these products and with market participants calling for a dependable third-party reference for the prices for these products.
Index-based trading also help to mitigate counter-party performance risk, Wright said.
“Buyers purchasing on a cfr basis are unlikely to walk away from contractual deliveries at current market rates, whereas flat price transactions [that] are well off the spot market price can result in counter-party performance issues,” he continued.
Indices such as Metal Bulletin’s fob China ones will also be helpful to counter-parties in physical spot trading, according to Price.
“Indices enable end-users to hedge their forward procurement costs and also provide domestic steel mills an effective means of managing their exposure to export markets,” Price said.
The varying grades of steel and the wide geographical area in Asia also allow for many opportunities for traders to hedge against a standard benchmark grade.
“Traders can explore the correlation between their products against a standard fob China HRC and rebar benchmark,” SSY Futures broker Zachary Ng said.
This was echoed by Singapore Exchange head of commodities derivatives William Chin, who said the fragmented steel markets offered opportunities for managing risks and profit-making.
“Index-linked pricing provides markets and clients with optionality and flexibility in managing price risk and opens an avenue to enhance returns in trading. This include arbitrage opportunities on a specification and product basis, as well as geographical opportunities,” he said. Doing it right It is important not to overexpose oneself in the derivatives market by diving straight in at the start, however.
“One should ensure that the hedging model they are using is in line with their company’s strategy, business model and risk appetite,” Ng said.
“It’s okay to start small… by doing partial hedging instead of hedging the entire cargo all at one go. For example, a trader can trade a portion of his cargo at a flat price, while enjoying a “floating” price for the remaining portion, he added.
Physical traders looking to hedge can also approach futures brokers to get impartial guidance, as well as risk management consultants who have experience in both physical and paper trading.
“Unless a company can see its exposure to the market changing on an up-to-the-minute basis, any attempts to hedge will ultimately be flawed. Those looking to hedge should have efficient mark-to-market models [that] enable them to design effective risk mitigation strategies,” Price said.