Among the comments in this morning's Opening Bell feature was a very reasonable - and all too often overlooked - question about the pricing of steel contracts.
In fact, when you hear about hedge funds losing billions on some big commodities trade, it's usually because the trader is fresh off the treasuries or equities desk, and treats his new job pretty much the same way he did his old one, using abstract theoretical pricing models, while oblivious to the forces of the real world.
As the reader points out, the volume for steel has recently plunged:
LME STEEL-Prices plunge to contract-lows on weak demand
The reason for this is mainly to do with the drying up of credit. As credit dries up, it becomes increasingly difficult to get the funds required to ship steel, or even to store it. The reason there's not a big arbitrage market for steel, as our reader wonders, is because unlike most markets, there is an element of time and logistics involved in the commodities market. The technology that accelerates the deal process when you buy say, a stock, is useless when transporting tons of steel around the globe.
For instance, say you want to take advantage between the price in the Far East ($300 a tonne) and stuff in the Black Sea ($450 per tonne) as our reader supposes. That's a lot harder than you think. First you have to find a ship. To illustrate how hard that is, one of the largest shippers in the world, Dry Ships, has a total fleet of 30! Added to that, you have to find a captain for the ship, and so on.
Moreover, there is the time involved in shipping the steel from place to place. Of course, steel which is in an area of the world with a higher demand relative to availability is going to have a higher price. But it's not something you can just expect to be delivered without any regard for the availability of transport, docks etc. That also affects the price.
It's a good issue to raise, and it's the reason so many people lose tons of money trading commodities. It's also one of the reasons commodities often have a much higher volatility than equities.
Posted by guest , Oct 16, 2008 10:34AM
since a lot of commodities are of different grades,etc. Hedging is tehrfore more difficult as well.
Posted by guest , Oct 16, 2008 10:35AM
since a lot of commodities are of different grades,etc. Hedging is tehrfore more difficult as well.
Posted by guest , Oct 16, 2008 10:35AM
since a lot of commodities are of different grades,etc. Hedging is tehrfore more difficult as well.
Posted by guest , Oct 16, 2008 10:38AM
you are tehrfore three times the twat.
Posted by guest , Oct 16, 2008 10:43AM
there's got to be some quant guys out there that can arb these commodities effetively...
Posted by guest , Oct 16, 2008 10:45AM
Daniel,
If you are in the Black Sea, you wouldn't buy a Far East contract. You would buy the Black Sea contract at $360.
http://www.lme.co.uk/Steel_Med_Prices.asp
Delivery would be made at the nearest LME warehouse in Europe. So no ocean shipping is required if there is an LME warehouse in your country (most major countries have).
Also, this pricing anomaly is not present in the other metal markets such as copper. The physical spot price for these metals are LME + premium. Check with metal traders to confirm.
Posted by guest , Oct 16, 2008 10:53AM
@4
Crorect
Posted by Daniel Harrison , Oct 16, 2008 10:53AM
@6 Steel has a different weight-to-value ratio than other metals. Also, steel requires dry bulk shippers (who also carry stuff like grain, coal and iron ore).
Posted by guest , Oct 16, 2008 10:57AM
What about Anhydrous Ammonia? Or frozen white shrimp? So many commodities plays out there.
Posted by guest , Oct 16, 2008 11:03AM
Ok. Here's a question:
I buy an LME contract at $360 and request for delivery. The counterparty to my contract will have to deliver the steel to me now. Where is he going to find the steel to deliver? If the steel mills are selling at $450, isn't he making an immediate loss?
Posted by guest , Oct 16, 2008 11:05AM
Is it that this article is really dumbed down, or just that you actually don't understand the trade/arbs?
That said, nice attempt and great point. Trading steel contracts w/o physical exp is playin with fire. Stick with more liquid contracts, more opps, less guessing
Posted by Daniel Harrison , Oct 16, 2008 11:08AM
@11 It's that the comment was querying arb opportunities in the steel market, which I was trying to show were not possible.
Posted by guest , Oct 16, 2008 11:09AM
Where's Marc Rich?
Posted by guest , Oct 16, 2008 11:27AM
Daniel, if you were trying to arb the difference in physical commodities at different locations you would buy and sell contracts to lock the a spread and at the same time arrange for physical delivery (shipping and insurance). Otherwise I fail to see how it classifies as an "arb".
Back in the 90's MS and GS would rent oil refineries, take physical delivery of crude and "crack" it into gasoline for a profit. It can be done you just have to have everything lined up before you pull the trigger.
My favorite arb is the buzing 10,000 lb bags of frozen white shrimp on the Minnesota Grain Exchange and selling them to the Ground Round in Piscatawy, N.J.
Posted by guest , Oct 16, 2008 11:27AM
Daniel, if you were trying to arb the difference in physical commodities at different locations you would buy and sell contracts to lock the a spread and at the same time arrange for physical delivery (shipping and insurance). Otherwise I fail to see how it classifies as an "arb".
Back in the 90's MS and GS would rent oil refineries, take physical delivery of crude and "crack" it into gasoline for a profit. It can be done you just have to have everything lined up before you pull the trigger.
My favorite arb is buying 10,000 lb bags of frozen white shrimp on the Minnesota Grain Exchange and selling them to the Ground Round in Piscatawy, N.J.
Posted by Anal_yst , Oct 16, 2008 11:48AM
@ 11/12
I prefer the Ground Round on rt 4, you make the trifecta with fuddruckers and the cheesecake factory for the epic 12,000 calorie fatass tour
Posted by Phobos , Oct 16, 2008 12:30PM
@Anal_yst
Piece mealing is the only way to go.
You can arb the difference in steel if you really, really want to -- but in my humble opinion with the time it takes getting all the dominos to fall "just so" -- probably not worth it.
Posted by guest , Oct 16, 2008 1:02PM
You really have to hire your own Captain? Dryships or whoever you charter from doesn't provide the crew?
Posted by guest , Oct 16, 2008 1:36PM
haha, frozen white shrimp. i think there's like 2 guys on the floor trading that.
Posted by Daniel Harrison , Oct 16, 2008 1:48PM
@17: Yes, exactly. That's the gist of this post. The question was why can't someone arb 2 different prices if you found a buyer in the area where there is more expensive stuff: ship from one loc to another and pocket the difference? The logistics just don't make it profitable.
@18: Some shippers have captains, some just provide the ships. That CAN BE and is sometimes an issue. As I say, there are not THAT many dry bulk shippers out there.
Posted by guest , Oct 16, 2008 1:54PM
@20
Shipping of steel billets (usually 20k mt per shipment) is usually done by containers, which is easily available. You don't need to charter an entire ship.
Ship chartering is only required for large tonnage goods such as iron ore or coal where 100-200k mt is the common tonnage.
Posted by guest , Oct 16, 2008 10:15PM
"In fact, when you hear about hedge funds losing billions on some big commodities trade, it's usually because the trader is fresh off the treasuries or equities desk, and treats his new job pretty much the same way he did his old one, using abstract theoretical pricing models, while oblivious to the forces of the real world."
Retard.