CHAPTER 3 METAL MARKETS AND PRICING MECHANISMS
| Jurisdiction | United States |
(Mar 1985)
METAL MARKETS AND PRICING MECHANISMS
Consultant on Metal Markets
New York, New York
Modern industry uses more than fifty different metals. Because of time constraints, the mechanisms by which metal prices are determined will be described in generalities rather than in detail. Those already familiar with the field will doubtless perceive many exceptions to the broad statements I will be making. Perhaps some of them can be noted in the discussion period. My purpose is to present a few useful concepts that may help in understanding this vast and fascinating trade.
No metals have identical pricing practices. The differences arise from factors of production, consumption, geography, volume, and long-standing traditions. Those desiring detailed data regarding a particular metal can readily obtain such information from trade publications or from government sources such as the U.S. Bureau of Mines.
One can identify four major procedures by which prices are arrived at for sales or purchases in the metal markets:
1. Prices established by producers.
2. Prices regularly reported by a reputable independent source, usually a periodical, after a careful survey of the market.
3. Prices negotiated directly between buyer and seller, either for a single transaction or to apply to a series of transactions over a period of time.
4. Prices resulting from offers and bids made by public outcry on the floor of a commodity exchange.
Only ten of the more than fifty metals are now actively traded on commodity exchanges. Thus pricing for more than forty commodities is based on one or more of the other three methods.
For most metals more than one system of price determination is currently prevalent. Indeed, in the case of many of the larger-tonnage metals, all four pricing mechanisms are typically in effect. As an example: Lead is traded on the London Metal Exchange, but not on the New York Commodity Exchange. In the European market most lead is sold on the basis of London Metal Exchange prices. In the United States, a substantial share of lead sales are based on average prices published in Metals Week. In Japan transactions are predominantly based on a producer price. In Brazil imported lead is sold at prices negotiated between the importer and the consumer.
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Regardless of the procedure used, however, among the market-economy countries metal price trends are determined primarily by worldwide conditions. Except for those periods when governments intervene in the markets through regulations to control prices, the metal markets are truly international. Transportation costs and trade barriers moderate, but do not prevent, the flow of metals in world commerce.
Obviously, the countries of the Communist bloc are in a separate category. Their trade is rigorously controlled by the state and their internal prices are arbitrarily established. Economic considerations are frequently subordinated to political and/or military goals. Nevertheless, in those commodities of which they are significant exporters, the Communist nations sell to the West at competitive prices — but they tend to be price followers rather than price setters.
Because of their global nature, metal markets are highly sensitive to fluctuations in foreign-exchange values. After the United States in 1971 terminated the dollar's tie to gold at $35 an ounce, the price relationships among the leading world currencies became extremely volatile. As a consequence, prices of given commodity may at times give the appearance of following disparate trends expressed in different currencies.
To illustrate what can happen, consider recent trends in the prices of copper and zinc, expressed in dollars and pounds sterling. In December, 1984, the monthly average price for highgrade copper in London was 1,113 pounds a metric ton, contrasted with the monthly average of 987 pounds in December, 1983. To an Englishman, the price rose 12.7% in twelve months.
But for his American counterpart, the same price, translated into dollars, looked quite different. Due to a drop in the dollar value of the pound from $1.43 in December, 1983, to $1.18 in December, 1984, London copper averaged 59.9¢ a pound in December, 1984, against 64.2¢ a pound in December, 1983, a decline of 6.7%.
The reverse of this had happened in the case of the zinc price between 1977 and 1980. During those years the pound's value had risen against the dollar. For the year 1980 the sterling price of zinc averaged 3.3% lower than in 1977, but the dollar equivalent in 1980 was 9% higher than in 1977.
It follows that in writing contracts involving international trade in metals, the designation of the currency becomes of paramount importance, even granted that possibilities exist
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for hedging exchange risks. Currency selection is also highly relevant to any charges involved in processing, transporting or insuring metals in international trade. For example, a smelter or refiner in Japan, even though willing to pay for metal content in dollars, may wish to have processing charges designated in yen — since his costs are yen-based. During the period of the weak dollar in 1977-1980, contracts involving processing costs designated in yen resulted in Japanese charges substantially above competitive costs available elsewhere.
Regardless of the currency involved or the procedure employed to establish them, commodity prices cannot ignore the balance between supply and demand. This has become abundantly clear over the last twelve years. The initial success of oil-exporting countries in pushing prices sharply upward through the mechanism of OPEC has been followed by the gradual weakening of prices as oil demand has contracted and uncontrolled oil supply has increased.
But while this basic truth remains unshakable, the rapidity of the response to the balance between supply and demand is greatly influenced by the way in which prices are determined. As a general proposition, when producers nominate prices they tend to be governed initially by the motive of covering costs plus a return on investment. On the other hand, when the price is established in an auction market, which fundamentally is a short-hand way of describing a commodity exchange, the immediate supply-demand balance is the principal price determinant, regardless of production costs.
These two methods — the producer price and the commodity exchange price — represent the two poles in pricing mechanisms for metals. The two other procedures — reported or published prices as determined by independent sources and prices resulting from buyer-seller negotiations — are typically somewhere in between. In cases where several individual producers are quoting different prices the use of an independent source for quotations results in a blend or averaging to arrive at a representative value. In those commodities not traded on exchanges, buyer-seller negotiations, even though not subject to the same public scrutiny as exchange transactions, perform a similar function of modifying the cost-based producer price to reflect current supply-demand considerations.
Most metals tend to have volatile price structures. The underlying cause of this volatility is that demand for metals
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fluctuates directly and sharply with the swings in the business cycle, while supply of metals tends to be relatively inflexible. At times supply will outrun demand, causing inventory accumulation and price weakness. At other times demand will rise rapidly while supply responds sluggishly, causing inventory liquidation and putting upward pressure on price.
Price volatility is not popular with producers, governments or consumers. Producers prefer stable and remunerative prices, so that they can proceed confidently with their programs for capital investment.
Governments of metal-exporting nations prefer stable prices that work toward maintaining predictable levels of foreign exchange earnings and tax revenues. Consumers prefer stable prices that enable them to predict raw material costs, to prevent balance-sheet distortions of inventory values, and to avoid frequent changes in the prices of their own manufactured products. All three segments — producers, governments, and consumers — are well aware that volatile metal prices may cause loss of markets through substitution, whereas steady prices tend to stimulate increased consumption.
As a consequence, repeated efforts have been made to devise systems to reduce, if not eliminate, price instability. Sometimes the efforts have been in the form of producer associations; sometimes through intergovernmental agreements involving both producing and consuming nations. Anti-monopoly legislation in many countries has been a deterrent to some private-industry attempts, but even where legal barriers do not intervene, instances of long-run success in price stabilization are rare indeed.
In the metal field, perhaps the nearest approach to successful price stabilization occurred in aluminum, molybdenum and nickel in the years following World War II. At that time, the world aluminum industry was dominated by a handful of producers, while in molybdenum and nickel a single producer accounted for most of the Free World output — Climax in molybdenum and International Nickel in nickel.
For all three metals during this period prices were maintained at levels that yielded an adequate return to the producers but that were low enough to support successful promotion of new applications. In the period between 1950 and 1973, Free World aluminum consumption increased at a compound rate of 8% annually. Nickel and molybdenum consumption increased at compound rates of about 6% annually. These gains were markedly greater than the
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level of growth recorded during those years by competitive metals with less stable prices.
During this era the infrequent changes in the prices of the...
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