There is good news on the horizon for the average American retail investor. A bubble is coming and, for once, Joe Investor will miss the boom and bust. Two main stories create the potential for a short-term meteoric rise in prices only to fall rapidly as macroeconomic forces and political problems resolve themselves. In a world filled with financial instruments, global exchanges, and products ranging from weather derivatives to technology indices and silkworm futures, the base metal nickel is inaccessible to the average American retail trader.
Ten years ago, nickel was trading around $ 11,200 per tonne on the London Metal Exchange (LME). Currently, the market is close to $ 18,500 per ton. The 65% increase in prices is almost a perfect correlation with the global GDP growth of the world’s five largest economies over the same time period. This basically makes sense, as nickel is used in nearly 3,000 alloys that we come into contact with on a daily basis. The rapid rise in nickel prices this year is not linked to global growth, but the post-peak nickel collapse will be directly linked to the slowdown in global GDP.
There are two main factors that are pushing nickel prices beyond its fundamental value. The first problem was no surprise. Indonesia, the world’s second largest nickel producer, imposed restrictions on the export of raw ore in January. The law is designed to boost Indonesian ore processing and increase national industrial development. Some concessions were made to companies with new national projects already in the works, such as Freeport-McMoRan, however even their production is likely to be cut in half according to the first quarter earnings report. Ultimately, the world could see a decrease in supply of more than 8% in 2014 due to the enactment of the Indonesian policy.
The second factor currently pushing nickel prices above its intrinsic value is the escalating political crisis in Ukraine. Russia produces about 16% of the world’s nickel. It also produces nickel with a significant cost advantage over Indonesia due to the geological formations in which it is stored. Norilsk Nickel dominates Russian nickel production. Norilsk Nickel, like Gazprom, is a quasi-governmental industrial company that will be on the short list of the next round of NATO sanctions, as well as direct US sanctions that are targeting individual Russian companies and owners, particularly through banking and tax controls.
These short-term supply concerns run counter to the macroeconomic outlook that continues to project a global slowdown. The Organization for Economic Cooperation and Development recently published its projections calling for world GDP to decline from 3.6% to 3.4%. This is also the second projected decline in six months. Highlights include the decline in Chinese GDP from 8.2% to 7.4%. This factor cannot be minimized considering that the five-fold growth of the Chinese economy over the last 10 years is largely responsible for the 50% increase in nickel prices during that same period. Ironically, Chinese production itself will be a contributing factor to the metal’s decline, as it is expected to increase its production by almost 50%, contributing nearly 500,000 tonnes of the 2014 global production of 1.85 million tonnes. . Finally, their increasing production efficiency will allow them to make a profit even if nickel falls below $ 12,000 per ton.
Futures markets are based on the delivery of a product at a given time at a price negotiated between the buyer and the seller of the product at the beginning of the contract. Physical products also have storage costs along with insurance to cover their value in storage. This creates a pricing structure where the longest lead times have the highest prices due to associated fees. This pricing structure is called backwardation. The opposite of this is “contango”. Contango occurs when the near price is higher than the long-term price. This pricing structure represents a short-term supply shortage.
The nickel market is currently in varying degrees of contango according to LME charts. Nickel for current delivery is currently trading at around $ 18,450 per tonne and nickel for three-month delivery is trading slightly higher at $ 18,520. Meanwhile, nickel for December delivery is $ 18,205 and nickel for December 2015 delivery is down. up to $ 17,805. These prices make it easy to see that the short-term increase in prices does not reflect the market outlook of the big picture. In addition, the lack of retail access for US investors to the LME makes it very difficult to trade on its exchange.
We have seen supply disruptions creating similar situations here in the US Typically the overpricing between intrinsic value and high market price is driven by media speculation, eventually flowing to the individual retail investor in Main St. USA Unfortunately, we’ve seen time and again where small traders jump on the news train in hopes of making a quick buck only to end up sinking with the ship once the market turns. These patterns are easy to see in the US futures markets due to the Traders Engagement Report released weekly by the Commodity Futures Trading Commission. This report tracks the actual buying and selling of individual trader groups: Trading, Index, and Small Speculator. We religiously monitor these reports and use them to keep us informed about the current outlook for the underlying industry in their respective markets. At least this time, the nickel bubble will not be filled with money from American summer vacations.