There’s good news on the horizon for the average U.S. retail investor. There’s a bubble coming and for once, Joe Investor is going to miss out on the boom and crash. Two primary stories create the potential for a short-term meteoric rise in prices only to quickly plunge as macro economic forces and political issues sort themselves out. In a world full of financial instruments, global exchanges and products ranging from weather derivatives to technology indexes to silkworm futures, the base metal nickel is inaccessible to the average retail American trader.
Ten years ago, nickel was trading around $11,200 per ton on the London Metals Exchange (LME). Currently, the market is near $18,500 per ton. The 65% climb in prices is nearly a perfect correlation to the global GDP growth of the world’s five largest economies over the same time period. Fundamentally, this 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 are not tied to global growth but, the post spike nickel collapse will be directly tied to the slowdown in global GDP.
There are two primary factors that are currently pushing nickel prices beyond their fundamental value. The first issue was no surprise. Indonesia, the world’s second largest nickel producer placed restrictions on the export of unrefined ore this January. The act is designed to boost Indonesian ore processing and increase domestic industrial development. Some concessions were made to companies with new domestic projects already in the works like Freeport-McMoRan (FCX) however, even their production is likely to be cut in half according to their first quarter’s earning report. Ultimately the world could see supplies decline by more than 8% in 2014 due to the Indonesian policy enactment.
The second factor currently pushing nickel prices above their intrinsic value is the escalation of the political crisis in Ukraine. Russia produces about 16% of the world’s nickel. It also produces nickel at a significant cost advantage over Indonesia due to the geologic formations in which it’s stored. Norilsk Nickel dominates Russian nickel production. Norilsk Nickel, like Gazprom is a quasi governmental industrial concern that will be on the short list of the next round of NATO sanctions as well as the direct U.S. sanctions, which are targeting individual Russian businesses and owners, particularly through banking and tax controls.
These short-term supply concerns fly in the face of the macro-economic picture that continues to project a global slowdown. The Organization for Economic Cooperation and Development recently released their projections calling for global GDP to decline from 3.6% to 3.4%. This is also the second projected decline in six months. Highlights include Chinese GDP declining from 8.2% to 7.4%. This factor can’t be minimized considering the Chinese economy’s five-fold growth over the last 10 years is hugely responsible for the 50% rise in nickel prices over that same period. Ironically, Chinese production itself will be a contributing factor to the metal’s decline as they’re expected to increase their production by nearly 50% contributing nearly 500,000 tons of the 2014 global production total of 1.85 million tons. Finally, their increasing production efficiencies will allow them to profit even if nickel falls below $12,000 per ton.
The futures markets are based on the delivery of a product at a given point in time at a price negotiated between the buyer and seller of the product at the inception of the contract. Physical commodities also have storage costs along with insurance to cover their value in storage. This creates a pricing structure where the longest delivery times have the highest prices due to the associated fees. This pricing structure is called backwardation. The opposite of this is, “contango.” Contango occurs when the nearby price is higher than the long dated price. This pricing structure represents a short-term supply shortage.
The nickel market is currently in varying degrees of contango according to the charts on the LME. Nickel for current delivery is currently trading around $18,450 per ton and nickel for delivery in three months is trading a bit higher at $18, 520. Meanwhile, nickel for December delivery is $18,205 and nickel for December 2015 delivery is all the way down to $17,805. These prices make it easy to see that the short-term spike in prices is not reflective of the market’s outlook of the bigger picture. Furthermore, lack of U.S. investor retail access to the LME makes it very difficult to trade on their exchange.
We’ve seen supply disruptions create similar situations here in the U.S. Typically the excess pricing between the intrinsic value and the elevated market price is fueled by media speculation, which flows, eventually to the individual retail investor on Main St. USA. Unfortunately, we’ve seen time and time again where small traders hop on the news bandwagon hoping to make a quick buck only to end up sinking with the ship once the market turns. These patterns are easy to see in the U.S. futures markets due to the Commitment of Traders Report published weekly by the Commodity Futures Trading Commission. This report tracks the actual buying and selling of the individual trader groups – commercial, index and small speculator. We track these reports religiously and use them to keep us informed of the underlying industry’s current outlook on their respective markets. At least this time, the nickel bubble won’t be filled with American summer vacation money.