Price Volatility is the Big Problem
Cable-makers are likely to say that the absolute level of materials is not the key issue. They can live with high material prices, so long as they are stable, almost as well as lower material prices, since cable selling prices can be adjusted to compensate for higher material costs. End-users, of course, would prefer to see low material prices so that they end up paying less for installed cables. Higher material prices may reduce cable demand from end users because of price elasticity in demand. In cable markets this is usually only a short-term effect, as end-users defer purchases for a while, hoping that material prices will fall, but eventually have to come back to the market to buy cable unless the whole project is suspended.
Hedge Funds Blamed
In recent months there have been on occasions fluctuations in the copper price of as much as 5% to 10% in a single day, which is an exceptionally high level of volatility. Metal market analysts have sought to explain this increased volatility in terms of new players in commodity markets, in particular hedge fund investors. Some investors seek to make gains through short-term, speculative investments, which generate additional volatility. Fund activity should not move prices against market fundamentals for long periods, but it may affect timing of peaks/troughs and increase price volatility. The amounts of money involved are massive: the Funds are estimated to have invested approximately US$100 billion in commodities markets, of which up to 5% is in base metals.
Hedge Funds Attracted by Commodities
There has been growing interest in commodities as an investment vehicle from various groups of investors in recent years. Many equity markets in the richer economies subsided in the wake of the collapse of the dotcom boom, while many developing country equity markets (e.g. South East Asia and South America) were badly affected by economic crises from the late 1990s onwards. As a consequence, investors looked to other opportunities in order to generate higher returns or to achieve a more balanced (lower risk) portfolio. Commodity markets were per¬ceived to offer potentially high returns, at a time when the performance of equity investments was generally unexciting.
Portfolios Include Base Metals
Copper and aluminium, the most liquid LME contracts, are the base metals that have attracted most attention from CTAs (Commodity Trading Advisors) and hedge funds. Different CTAs may respond in the same way to “technical analysis”, so there can be big price movements when funds act together. As well as investing directly by taking positions on commodity contracts, investors can also buy and sell commodity indices on major futures exchanges. These indices cover a portfolio of commodities, weighted according to trading activity, for example the Goldman Sachs Commodity Index (3.1% Cu, 3.2% Al) and the Reuters / Jeffries CRB Price Index (6% Cu, 6% Al).
Also Longer Term Investors
Some investors, like hedge funds, do use commodity markets with a short-term horizon, in some cases adopting substantial speculative positions, but other investors have adopted commodities as part of a long-term portfolio of investments. These longer term players include institutional investors, such as pension funds and mutual funds. Some major pension funds have shifted part of their investment portfolio to commodities and, even though the percentage in commodities is not high (typically 2% to 5% of total assets), the scale of these funds is very large. The total value of the British Telecom Pension Scheme, for example, is £34 billion, so even 3% in commodities is a big number.