Steel Futures - A New Investment Opportunity

The fragmented nature of the industry, from iron ore mining to steel for cars and dishwashers, has made it hard for paper-based investors to get involved.

But for those investors who can't tell the difference between hot rolled coil and wide flange beams there is now a way to tap into this market as the London Metal Exchange launches its first steel futures. The securities are currently being traded only via the phone and on the LME's electronic platform LME Select, but will go into full open outcry trading on the LME floor alongside copper, aluminium and other metals from 28 April.

The first week started quietly, with only a few large LME brokers such as Standard Bank and Sempra Metals getting involved. Some 108 lots - each lot is 65 tonnes - were traded and the total value of exchanged contracts was approximately $5.5 million, according to the LME's David Wiggin. For comparison, the LME's aluminium futures, currently the exchanges most active contract, traded 40 million lots in 2007.

Part of the reason for the lack of fanfare was the guarded response from the steel industry, especially from the largest producers such as ArcelorMittal, Tata Steel and China's Baosteel. Most of them don't want to relinquish the pricing of their product to the LME and believe that futures trading will bring greater volatility to prices rather than reduce them.

Charles Bradford, president of New-York based Bradford Research, said the aluminium contract faced similar resistance when it was launched and it took ten years before it started to dominate pricing. "We are living in a faster moving world now, and steel is likely to take off much sooner," said Mr Bradford.

But banks and brokerage houses already trading on the London Metal Exchange were more optimistic about the prospects of the contract.

"We are currently not involved in steel but we expect that once steel gets included in commodities indices such as Goldman Sachs' commodities index or Dow Jones-AIG index commodity funds will start including steel futures and trade will pick up," said a source at an LME member firm.

Despite this tentative start the sheer size of the industry is likely to attract investors. The asset value of the global steel industry is estimated at around $440 billion, compared with about $130 billion for the base and precious metals. Also, its annual turnover is a massive $200 to $300 billion.

For investors looking to get involved in steel the current route is to go through LME brokers. Going forward, there is likely to be an option of exchange traded commodities. These are exchange listed shares which track a commodity but buffer investors from trading futures or having to buy physical metal.

ETF Securities, the largest provider of exchange traded commodities, isn't currently providing steel ETCs but says that it will consider doing so in the future.

The steel launch comes at a time when steel prices are high, on the back of strong demand and an increase in the raw materials - iron ore and hard coking coal - and look set to stay that way.

Prices for one of the major steel products - hot rolled coil - have spiked by $200 a ton of hot rolled coil in 2008 alone. "We believe that the price hikes so far are just beginning," said a report by Credit Suisse in which the bank forecast a price rise for this type of steel to $1,000 by 2009 as the market remains undersupplied.

Lehman Brothers is predicting that global demand for steel will grow by 5.5 per cent in 2008, slightly less than the 5.8 per cent in 2007. Steel prices are expected to continue to rise on the back of Chinese demand, which continues unabated.

Presuming that the LME futures are successful - and that seems a reasonable expectation given the sheer size of the industry and the LME's track record - investors who get involved in the market in the early stages may have some great arbitrage opportunities to exploit.

How good an investment it will be long term, and how soon it will yield respectable returns, will hinge largely on the volume of trade on the LME and how quickly those volumes are built up to make prices representative.

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