Metal Trading at the London Metal Exchange

Analytical Finance I The London Metal Exchange (LME)

• One of the leading international commodity exchanges. • Accounts for about 95% of global exchange business for the metals it trades. (Base Metals)

Copper $3957/MT Primary Aluminium $1935/MT Lead $964/MT Zinc $1494/MT Nickel $12725/MT Tin $6580/MT Aluminium Alloy $1655/MT

2 | November 13, 2005 | Analytical Finance I The History of LME

• The origin of LME can be traced back to the opening of the Royal Exchange in 1571.

• “The Jerusalem Coffee House of Cornhill”

• The Industrial Revolution: the U.K. needed to import large tonnages of metal => the start of the LME futures market.

3 | November 13, 2005 | Analytical Finance I Trading at LME

Currently three different ways to trade on the LME:

• Open outcry market – “Ring Trading”

• Telephone market

• LME Screen Trading System – “LME Select”

4 | November 13, 2005 | Analytical Finance I The LME Ring

5 | November 13, 2005 | Analytical Finance I Market Terms

• Buy/Sell

• Warrants Bearer documents of title, each warrant entitles to take position of one lot of metal at a specific LME warehouse.

• Lot The minimum amount of a commodity in which one may deal on a futures market.

Copper, Aluminium, Lead, Zinc 25 metric tonnes Aluminium Alloy 20 metric tonnes Nickel 6 metric tonnes Tin 5 metric tonnes

6 | November 13, 2005 | Analytical Finance I Market Terms

• The second ring Takes place during 13.30-1400 CET. Five minutes trading sessions for each metal, starting with copper.

• Settlement price The last unfulfilled offer to sell cash at close of the second ring (cash seller). The settlement price is the accepted cash reference price for the metal for the succeeding 24-hours.

7 | November 13, 2005 | Analytical Finance I Market Terms

• Prompt date The date on which the metal has to be delivered to fulfil the contract terms.

Cash date

”t+2” system

Trading day Prompt/cash date Monday Wednesday Tuesday Thursday Wednesday Friday Thursday Monday Friday Tuesday

8 | November 13, 2005 | Analytical Finance I Market Terms

• Future trading dates:

• 3 Month date The reference price for all metals traded at the LME. • Weekly date Every Wednesday • Monthly date The 3rd Wednesday in every month

• E.g. Copper trading Cash-3M Daily trading dates 3M-6M Weekly trading 6M-63M Monthly trading

9 | November 13, 2005 | Analytical Finance I Market Terms

Forward price spreads: Contango • The situation when the price of the metal for future delivery is greater than the cash price of the metal. • “Normal” market conditions. • The size of the contango is a function of the cost of storing, financing and insuring the metal over the future delivery period.

Zinc S pread

1485 1480 1475 MT / Zinc Cash-3M Spread,

D 1470 closings Oct 12.

US 1465 1460 Contango market 1455 H 5 5 5 5 5 5 5 5 5 5 5 6 6 S 0 -0 -0 -0 -0 -0 -0 0 -0 -0 0 05 -0 T- T V V V V V C- C C C- C- N-0 N CA C C O O O E E E E JA A -O -O N -N -NO -NO N -D -D -D -D -DE - -J 0 1- 7 4 8 5- 1 9 3 3 9 2 26 0 0 1 1 2 0 07 13 1 2 0 0 Da te

10 | November 13, 2005 | Analytical Finance I Market Terms

Forward price spreads: Backwardation • The situation when the price of the metal for future delivery is lower than the cash price of the metal. • Reflects a tight market. • “No limits” in size, determined by supply/demand factors.

Copper Spread

4100 4050

T Copper Cash-3M Spread,

M 4000 closings Oct 12. D/ 3950 Backwardation market US 3900 3850

5 5 5 5 5 5 5 5 5 5 5 5 6 6 H -0 -0 -0 0 -0 -0 -0 0 -0 -0 0 -0 S T T V V- V V V C- C C C- C N-0 N-0 C C CA O O E E JA JA -O -O -NO -N -NO -NO -N -DE -DE -D -DE -D

20 26 01 07 14 18 25 01 07 13 19 23 03- 09- Dates

11 | November 13, 2005 | Analytical Finance I Market Terms

Carries: Lending and Borrowing

• Lending “Lending metal to the market”, i.e. sell cash and buy forward.

• Borrowing “Borrowing metal from the market”, i.e. buy cash and sell forward.

BACKWARDATION ”BBC – Borrowing in Backwardation Costs”

Earns Costs Money Money Lend Borrow

Costs Earns Money Money

CONTANGO

12 | November 13, 2005 | Analytical Finance I Market Terms - summary

Trading date: October 17 Cash date: October 19 (3rd Wednesday) Long position: 100 tonnes Cu on October 19 Want to sell 100 tonnes on October 19 and buy 100 tonnes on November 16.

Lend 4 lots cash to November.

13 | November 13, 2005 | Analytical Finance I The Copper Market

14 | November 13, 2005 | Analytical Finance I