The Shanghai Futures Exchange (SHFE) started making news in November of 2003, when, for the first time in its history, copper contract volumes on the SHFE exceeded those on the London Metal Exchange (LME). Since that time, the SHFE has taken a leading position among copper exchanges, with the metal trading at a premium relative to the LME and the Comex division of the New York Mercantile Exchange.
According to "Copper Futures: the New Money and the Old," a feature that was published in the July/Aug. 2005 issue of Futures Industry magazine, "in the 19 months from October 2003, the point of take-off, through April 2005, SHFE’s contract volume topped the LME’s 13 months out of 19."
Despite its leading position, the SHFE has little relevance for many U.S. scrap recyclers, other than as an indicator of trends. Copper on the SHFE generally trades at a premium of nearly 15 percent relative to the LME, therefore the price doesn’t directly apply to North American or European processors who are shipping material to consumers outside of China.
MARKET BREAKDOWNJohn Chen of Tung Tai Group, San Jose, Calif., says the Comex exchange ranks third in terms of volume of copper contracts behind the LME and the SHFE. However, it is important to note that the SHFE contract lot size is 5 metric tons, where the LME contract is 25 metric tons.
Tung Tai has 11 processing facilities and trading offices in the United States, Taiwan and China. As a processor of electronic scrap and scrap metal, the company’s Chen has become familiar with the SHFE.
"Contract volumes are higher for Shanghai only because there is a five-to-one advantage," Chen says. "But, when you look at the tonnage volume, the LME is almost double."
Contract volumes on the SHFE grew from 750,000 lots in November of 2006 to 4.6 million lots in November of 2007, an increase of nearly 510 percent, according to figures supplied by the SHFE. For the month of November 2007, 2.2 million lots of copper futures were traded on the LME, according to data from the exchange.
As far as inventory levels are concerned, during November of 2007, the LME averaged 180,000 metric tons in copper stocks, while the SHFE averaged 55,000 metric tons. Chen says inventory levels on the SHFE have ranged from a low of nearly 20,000 metric tons earlier this year to a high of 100,000 metric tons this summer. The LME does not experience such wide fluctuations, however, and is generally between 100,000 to 200,000 metric tons.
"When working with the LME, China and Comex, like we do, generally material is moving from developed countries to China, so most people would be buying based on the LME or Comex, whatever their suppliers are used to," Chen says. For U.S. suppliers, Comex figures generally apply, while the rest of the world, including China, uses the LME.
"What I’ve heard from most traders is, because the demand is based in China, the SHFE typically is leading because demand leads supply in a lot of cases," Chen adds. "Until we reach the point where copper prices are not determined by demand but by lack of supply or other factors, demand is mostly coming from China, and price movements in general are lead by China."
Price volatility is closely correlated on the LME and SHFE, though pricing is generally higher on the SHFE. "Traditionally, Shanghai’s copper price has been 8 to 21 percent higher than the LME’s for the exact same month and material," Chen says, adding that pricing on the LME and Comex tend to be similar. "It’s not like anything else I’ve ever seen," he says of the higher SHFE price.
For example, the LME copper price for Dec. 6, 2007, was $6,725 at one point in the trading day. Multiplied by a 7.4 exchange rate, Chen says, copper should have been at 49,765 renminbi on the SHFE based on a pure exchange rate. However, February copper contracts were at 57,030 renminbi on the SHFE, a 14.5 percent premium relative to the LME contract.
This difference, in effect, gives sellers an arbitrage opportunity, Chen says. "You are basically buying low and selling high."
He attributes the premium to customs duties, freight expenses and taxes.
"If I am someone in Chicago who is running a scrap yard, it would be almost unfair for me to look at the Shanghai Exchange because I see prices that I could never get domestically," Chen adds.
VOLATILITY AND THE SHFEThe SHFE is not as speculative as the other markets in light of the number of corporations with exchange membership. According to the SHFE Web site (www.shfe.com.cn/Ehome), the exchange has more than 200 members, approximately 80 percent of which are futures brokerage firms.
However, as the number of individuals with membership in the Shanghai Futures Exchange increases, speculation could also increase.
"They are saying now that probably nine out of 10 accounts or traders are individuals as far as numbers, but they only represent a little over half of the volume," Chen says.
Hedge funds also exert less influence over the SHFE. "China is less influenced by large hedge funds, whereas large hedge funds are a big business in the U.S. and throughout the developed nations," Chen says.
The SHFE will not follow the LME if the exchange is being artificially influenced by hedge fund activity, he adds. "They are correlated as far as increasing or decreasing," Chen says of the relationship between the LME and SHFE, "but a lot of times, China does determine certain limits, either downward or upward, and the LME follows. If the LME tries to push upward, and Shanghai does not push upward, the LME will fall back down to its place, which was always within a 9 and 15 percent premium in the last year."
If the markets fall out of this range so that the LME gets to within 7 percent or 6 percent of the SHFE, Chen says, traders know Shanghai will go up or the LME will go down, because the premium remains fairly consistent.
The SHFE also has a frozen limit, which means that trading is done for the day if the market reaches the 4 percent limit up or limit down. This helps to limit the exchange’s volatility.
As China continues to consume the majority of the world’s copper, the Shanghai Futures Exchange will continue to exert its influence, acting as a prominent exchange in Asia.
The author is managing editor of Recycling Today and can be contacted at dtoto@gie.net.
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