US ferrous scrap futures 101

Mar 26, 2013 | 07:00 PM | Gregory DL Morris

Tags  US ferrous scrap futures, exchange-traded futures contracts, U.S. Midwest No. 1 busheling ferrous scrap futures contract, CME Group Inc.,

Commodities, from iron ore to steel to scrap to soybeans to orange juice, are bought and sold either on an immediate-delivery basis (called the cash, or prompt, market), or as a contract for future delivery. Through all stages of the commodity price cycle, futures enable buyers and sellers to lock in prices, volumes, quality and delivery dates.

Futures, among the earliest risk-management tools, have been used for almost two centuries by farmers and processors of agricultural products to mitigate the huge volatility caused by weather, pests, consumer demand and transportation issues. Other commodities, such as fuels, also lend themselves to risk management through futures due to volatility that often is driven by geopolitical risk or supply disruption.

In contrast, ferrous metals--and steel in particular--have been slower to adopt futures because temporal effects, such as weather and political upheaval, are less of a factor, and huge global production volumes create a buffer against outages, so supply is not easily disrupted except on a highly localized basis.

The weight and volume of ore, steel and scrap products drive logistics to fewer, larger hauls, as well as to large inventories--another structural hedge against outages, but at the same time a financial risk due to inventory cost. In scrap, there also has been another factor working against the use of futures: an asymmetrical market with a relatively small number of large mills or trading companies buying from a relatively large number of smaller scrapyards and other sellers. In any market in which one side routinely sets terms, there is less need for that side to use outside risk-management tools.....

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