commodities trading 2011
TRANSCRIPT
FINANCIAL MARKETS SERIES
COMMODITIESTRADING
MARCH 2011
TheCityUK is an independent membership body, establishedin June 2010, promoting the UK financial and relatedprofessional services industry.
TheCityUK’s key areas of activity include:
• Promoting the UK-based industry as a world leaderoffering unrivalled service and expertise to partnersaround the world.
• Creating a partnership for a sustainable industry:demonstrating the industry’s role in enabling growth andprosperity in the wider UK economy.
• Using research, evidence, insight, data and analysis tomeet the needs of its members and to provide theevidence to support our promotional objectives.
COMMODITIES TRADINGMARCH 2011
The trading of commodities consists of physical andderivatives trading. This report mainly focuses oncommodity derivatives that are traded on exchangesand OTC derivatives markets. The report also gives anoverview of the global bullion market and London’simportance as the largest market in the world for goldand silver trading.
SUMMARYCommodities have seen an upturn in the volume of trading on exchangesin recent years. The number of contracts traded increased by nearly a half inthe three years up to 2010 (Chart 1), following on from strong growth seensince the start of the decade. This was largely a result of the growingattraction of commodities as an asset class and a proliferation of investmentoptions which has made it easier to access this market. On the other hand,the notional value outstanding of OTC commodities derivatives fell by two-thirds during this period, as investors reduced risk following a five-foldincrease in value outstanding in the previous three years. London is one ofthe main global centres for commodities derivatives trading along with NewYork and Chicago. While Chicago is predominantly a domestic market,London and New York source a large volume of international business.
Commodity assets under management more than doubled between 2008and 2010 to nearly $380bn. Inflows into the sector totalled over $60bn in2010, the second highest year on record, down from the record $72bnallocated to commodities funds in the previous year (Chart 2). The bulk offunds went into precious metals and energy products. The growth in pricesof many commodities in 2010 (Chart 3) contributed to the increase in thevalue of commodities funds under management. For example, the price ofgold posted a record high during the year and silver a 30 year high.
OTC derivatives trading The notional value outstanding of OTCcommodities’ derivatives contracts fell 3% in the six months to June 2010to $2.9 trillion, extending the fall from the previous two years. Preciousmetals accounted for 19% of the value outstanding at the end of 2010,down from 41% a decade earlier as trading in energy derivatives rose. Alarge proportion of trading in precious metals takes place on the OTCmarket in London. The average daily volume of gold and silver cleared atthe London Bullion Market Association (LBMA) in December 2010 was 18.0 million ounces (worth $25.0bn) and 99.7 million ounces ($2.9bn)respectively. This means that an amount equal to the annual gold mineproduction was cleared at the LBMA every 4.4 days, and to the annual silverproduction every 7.5 days. London is also a leading centre for energybrokers operating in energy and carbon markets.
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exchange trading ofcommodities
up 47% inthree years
Chart 1 Commodities trading
% change
1 June 2010 for OTC derivatives; 2 Number of contracts traded; 3 Notional value outstandingSource: BIS, IMF; FIA; TheCityUK estimates
-100
0
100
200
300
400
500
2008-20101
2005-2008
OTC derivatives3Physicalexports
Exchangetrading2
486
-66
97
47 52
-2
Chart 2 Commodity assets under management
Source: Barclays Capital
$bn, assets undermanagement (bars)
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400
20102009200820072006200510
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$bn, annual inflow (line)
Exchange-traded commodities The value of commodities tradingon exchanges increased by around a fifth in 2010 to over 2,500 millioncontracts. Trading on exchanges in China and India has gained inimportance in recent years due to their emergence as significantcommodities consumers and producers. China accounted for more than60% of exchange-traded commodities in 2009, up on its 40% share in theprevious year.
The outstanding value of funds invested in commodity markets throughindices, medium term notes and exchange traded products (ETPs) totalled$310bn at the end of 2010, up from $215bn at the end of 2009 and$113bn in 2008 (Chart 4). The increase in value was primarily triggered bystrong inflows into precious metals backed ETPs.
Major derivatives exchanges located in London account for around 15% ofglobal trade in commodities: Euronext.liffe, Europe’s biggest exchange for‘soft commodities’; London Metal Exchange, the leading global exchangefor non-ferrous metals; and ICE Futures Europe, the biggest exchange forenergy products in Europe. The UK is also home to a number ofinternational commodity organisations such as the International CoffeeOrganisation, International Cocoa Organisation and International SugarOrganisation. London as the leading international financial centre benefitsfrom being the preferred location for many international firms trading incommodities as well as investment banks and other financial institutionsthat trade in commodities derivatives.
COMMODITIES MARKETSTrading of commodities consists of direct physical trading and derivativestrading. Commodities include a range of diverse products (Table 1). Morerecently there has been growing sophistication of commodities investmentswith the introduction of new “exotic” products such as weather derivatives,telecommunications bandwidth, gas and power derivatives andenvironmental emissions trading. Other products that are traded on commodity markets include foreign currencies and financial instrumentsand indexes. These are the focus of separate TheCityUK reports.
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COMMODITIES TRADING MARCH 2011
commodity assets under management
double in three years to $380bn
Chart 3 Commodities, stocks and bonds
Index, 2000=100
Source: GSCI, Barclays, S&P
Goldman SachsCommodity Index
BarclaysAggreg. Bond Index
S&P 500
50
100
150
200
20102009
20082007
20062005
20042003
20022001
2000
Commodities markets
Physical trading
accounts for most of trading onexchanges. Traders includehedgers, speculators andarbitragers. Dominates softcommodities’ trading.
Precious metals and more recentlyenergy contracts are often tradedthrough OTC derivatives markets.
accounts for a small proportion oftrading on exchanges. It is typicallyused to balance out an excess ofdemand or supply on the physicalmarket (not a focus of this report).
accounts for most OTC trading.Participants include farmers,refiners, wholesalers. Trading isdone on the spot and forwardsmarket and is delivery based (not a focus of this report).
Exchange trading (standardised contract size andmaturity dates)
OTC trading(individually tailored)
Derivativestrading
Chart 4 Commodity exchange traded products and indices
Source: Bloomberg, ETP issuer data, Barclays Capital
$bn, assets under management
0
50
100
150
200
250
300 Exchange traded products
Indices
20102009200820072006200591% 50%
9%
50%
1 In placing reliance on other organisations’ statistics, we cannot guarantee a totaldistinction between physical and derivatives trading statistics.
MARCH 2011COMMODITIES TRADING
Commodities trading is conducted on OTC markets and exchanges, andconsists of spot trading, physical forwards and derivatives.
OTC commodities markets
Physical trading OTC commodities markets are essentially wholesalemarkets in which individually-tailored contracts are traded. The mostpopular physical commodities contracts can be broken down into: metals, energy, grains and soy, livestock, food and fibre and exoticcommodities. A large proportion of OTC commodities’ trading is transactedbetween producers, refiners and wholesalers on the spot market. Trading isdelivery based and typically done through intermediaries. For mostcommodities that are physically traded there is no market in a centralmeeting place and where it exists it typically handles only a small part of thetotal trade.
Derivatives trading The notional value outstanding of banks’ OTCcommodities’ derivatives contracts fell 3% in the six months to June 2010to $2.9 trillion (Chart 5). This was down two-thirds on the valueoutstanding three years earlier as investors reduced risk following a five-foldincrease in value outstanding in the previous three years. Commodities’share of the overall notional value outstanding of OTC derivatives fellduring this period from around 2.0% to 0.5% as investors retreated fromthis market due to uncertain global economic conditions. Precious metalsaccounted for 19% of the total in 2010, down from their 41% share adecade earlier as trading in energy derivatives rose. The vast majority ofOTC derivatives trading is in interest rate contracts and foreign exchangecontracts.
OTC trading accounts for the majority of trading in gold (Chart 11). Twiceas much gold was traded on OTC markets than on exchanges in 2010.Around 40% of silver is traded on OTC markets. London is by far thelargest global centre for OTC transactions in precious metals and accountsfor much of global physical trade. Other important centres include NewYork, Zurich and Tokyo. London is also a leading centre for energy brokersoperating in energy and carbon markets. More on this can be found inTheCityUK reports Derivatives Trading 2010 and Carbon Markets 2010.
Exchange traded commodities Exchange trading provides a centralregulated market in which large numbers of buyers and sellers can cometogether to deal in a competitive, transparent and open environment.Derivatives exchanges are more standardised in terms of contract sizes,maturity dates and margin requirements than OTC markets and tend todominate trading of ‘soft commodities’. The vast majority of trading oncommodity exchanges is in derivatives.
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Chart 5 OTC derivatives trading of commodities
0
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20092008
20072006
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1 June; 2 BIS interpretation of commodity derivativesSource: Bank for International Settlements
Notional value outstanding, US dollars billions, end-year2
Othercommodities
Gold33%
59%
15%
81% Otherpreciousmetals
8% 4%
Chart 6 Commodity trading on exchanges
1 September 2010 for number of contracts outstandingSource: Bank for International Settlements, TheCityUK estimate
Annual number of contracts traded, millions (bars)
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Number of contracts outstanding, millions (line)
Twice as much goldis traded on OTCmarkets than on
exchanges
Table 1 Physical commodity breakdown
GrainsCornSoybeansWheatOatsSoy mealSoybean oilRice
PreciousmetalsGoldPlatinumSilver
Food & FiberCocoa CoffeeCottonLumberOrange juiceRubberSugar
IndustrialmetalsAluminiumCopperLeadNickelPalladiumZinc
MeatsCattleHogs
EnergyCrude oilHeating oilNatural gasUnleaded gas
TheCityUK estimates that commodities trading on exchanges increased byaround a fifth in 2010 to over 2,500 million contracts. This follows a 19%increase in the previous year (Chart 6). Most of the growth in trading inthese two years was in non-precious metals and agriculture contracts.
The outstanding value of funds invested in commodity markets throughindices, medium term notes and ETPs totalled $310bn at the end of 2010,up from $215bn at the end of 2009 and $113bn in 2008 (Chart 4). Theoutstanding value of funds invested in ETPs more than tripled in value in thetwo years up to the end of 2010 to $155bn. Precious metals accounted formore than three quarters of assets under management, commodity indices13%, and energy products for most of the remainder (Chart 7). Theoutstanding value of funds invested in commodities indices increased to$155bn in 2010 from $111bn in the previous year.
Commodity exchanges have gradually developed from physical marketswhere deals were made out of warehouses to futures markets which allowfor both hedging to protect again losses in a declining market and speculation for gains in a rising market. The derivatives markets for futureswere developed initially to help agricultural producers and consumers manage their price risks. Commodities accounted for 9.0% of the value ofglobal exchange-traded derivatives in 2010. This was up from 6.4% twoyears earlier and less than 3% in 2005. During these five yearscommodities’ share of the number of contracts outstanding increased from8.7% to 12.3% (Chart 8).
Largest commodity exchanges Worldwide, there are around 50 major commodity exchanges that trade in more than 90 commodities. ‘Soft commodities’ are traded around the world and dominate exchange tradingin Asia and Latin America. Metals are predominantly traded in London, NewYork, Chicago and Shanghai. Energy contracts are mainly traded in NewYork, London, Tokyo and the Middle East. More recently a number ofenergy exchanges have emerged in several European countries.
In terms of the number of futures contracts traded, in 2009 China and theUK had three exchanges amongst the largest ten, the US two and Japanand India one each (Table 2). The Dalian Commodity Exchange was thelargest commodities exchange in the world followed by the ShanghaiFutures Exchange and CME Group. The UK’s ICE Futures Europe was fifthand the London Metal Exchange seventh. Trading on exchanges is fairlyconcentrated. In 2009 the top five exchanges accounted for 86% ofcontracts traded globally up on their 82% share in the previous year.
China and India have gained in importance in recent years with their emergence as significant commodities consumers and producers (Chart 9).Over the past decade a number of large exchanges have opened in Chinaand India such as the Shanghai Futures Exchange, Zhengzhou CommodityExchange and the Dalian Commodity Exchange in China and the NationalCommodity and Derivatives Exchange and MCX in India. Chineseexchanges accounted for more than 60% of exchange-traded commoditiesin 2009, up on their 40% share in the previous year.
BULLION MARKETSTheCityUK estimates that the market value of above-ground gold stockstotalled around $7.6 trillion at the end of 2010 with turnover of $25.1
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COMMODITIES TRADING MARCH 2011
Chart 7 Exchange-traded commodity securities
Source: Bloomberg, ETP issuer data, Barclays Capital
Assets outstanding of exchange-traded products, end-2010
Industrial metals,1%AgricultureEnergy
Indices
Preciousmetals
13%
77%
6%3%
Total: $155 billion
Chart 8 Relative importance of exchange trading
Source: Bank for International Settlements
Commodities as % shareof global derivatives exchange trading
0
3
6
9
12
15
20102009200820072006200520042003200220012000
Turnover (contracts)
Number of contracts outstanding
Table 2 Largest commodity derivatives exchanges
Source: World Federation of Exchanges
Number of futures contracts traded (millions), 2009
834435431227165161106391411
Dalian Commodity ExchangeShanghai Futures ExchangeCME GroupZhengzhou Comm. ExchangeICE Futures EuropeMulti Comm. Exchange of India London Metal ExchangeICE Futures U.S.Mercado a Término de Buenos AiresNYSE Liffe
ChinaChinaUSChinaUKIndiaUKUSArgen.UK
AgricultureNon-prec. met.Energy, metals, agr.AgricultureEnergyAgricul. met. ener.Non-prec. metalsEnergyAgricultureAgriculture
Commodities’ exchangetraded products
triple in value in two years
MARCH 2011COMMODITIES TRADING
trillion during the year (Chart 10). The value of turnover increased by over aquarter in 2010, and nearly doubled on the value of turnover three yearsearlier. Around two-thirds of gold trading was conducted on OTC markets,and the remainder on exchanges.
The value of above-ground stocks and estimated turnover of the silvermarket totalled $22bn and $3.2 trillion respectively. The value of near-market silver or silver that is easily available from above ground stocks (inbullion form or scrap) is however much higher. The value of silver turnoverincreased by 57% in 2010. Around 40% of silver trading was conducted onOTC markets, and the remainder on exchanges.
Although the value of above ground gold and silver is relatively small compared to the global equity and bond market, the gold and silvermarkets have a much higher turnover as a proportion of market value. Itshould be noted however that estimates in Charts 11 and 12 of the volumeof gold and silver trading are conservative as they do not include allexchange-traded volumes or OTC trading that is cleared outside of London.
OTC trading Most trading in gold and silver is conducted on the OTCmarket. Because the minimum lot size of trading is typically high, the OTCmarket is dominated by institutional investors and gold marketprofessionals. The OTC market trades 24 hours per day and has no formalstructure and no central meeting place. Business is mainly conducted bytelephone or through electronic dealing systems. The global centre for suchtrading is London. Other large OTC markets include New York, Zurich,Tokyo, Sydney and Hong Kong. Some OTC business in kilogram and smallerbars for jewellery manufacture and personal investment is conducted inseveral other cities in Asia and the Middle East. Although the physicalmarket for gold and silver is distributed globally most wholesale trades arecleared through London.
It is difficult to quantify the size of the OTC market as it is less transparentthan exchanges. London Bullion Market Association’s (LBMA) clearingstatistics however provide an indicator of the trend in market turnover. Theaverage daily volume of gold and silver cleared at the LBMA in December2010 was 18.0 million ounces (worth $25.0bn) and 99.7m ounces($2.92bn) respectively (Charts 13 and 14). This compares with annual globalmine production of gold and silver of approximately 80m ounces and 750mounces respectively. This means that an amount equal to the annual goldmine production was cleared at the LBMA every 4.4 days, and to the annualsilver production every 7.5 days.
Reported LBMA turnover in both gold and silver has risen sharply in recentyears in terms of value traded partly due to the increase in prices in thesecommodities and their “safe-haven” appeal. Reported volumes significantlyunderstate actual volume of London market turnover which is probablythree to five times the reported value because transactions are increasinglynetted out and cleared without appearing in the statistics. Because mostgold is traded through London, LBMA clearing figures represent the resultof worldwide gold trading. It is estimated that around three-quarters ofgold and a half of silver transactions originate from outside the UK.
Notional amounts outstanding of OTC derivatives gold contracts totalled
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Chart 9 Regional split of exchange-traded commodities
% share, number of contracts
Source: World Federation of Exchanges
0
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20
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40
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60
70
80 20092008
Europe, Africa, Middle East
Asia PacificAmericas
Chart 10 Size of the gold and silver market
0
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Equity market
1 includes COMEX, TOCOM and 3 times LBMA turnover; Source: TheCityUK estimates
$bn, 2010
0
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TurnoverMarket capitalisation
SilverGold22
3,182
25,088
7,618
63,054
53,727
$bn, 2010
$417bn in June 2010, down 2% on previous year (Chart 5), and 35%below the peak in June 2008. The value traded in gold futures and optionsis on a long-term upward trend, and has nearly doubled during the pastdecade.
Trading on exchanges Gold and silver can be traded on exchanges inthe form of futures and options, and gold and silver backed securities:
Futures and options trading of gold and silver has gained in importance inrecent years. Turnover of gold increased more than 60% in 2010 to arecord $8.2 trillion (Chart 15). This was partly due to the increase in theprice of gold during the year. The value of silver traded on exchanges nearlydoubled in 2010 to $1.9 trillion (Chart 16). The main commodity exchangesfor gold and silver are Comex in New York, Tocom in Tokyo and morerecently MCX in India. Gold can also be traded on other commodityexchanges including the Chicago Board of Trade, Istanbul Gold Exchange,Chinese Gold and Silver Exchange Society, the Shanghai Gold Exchange andDubai Commodity Exchange. Only a small percentage of the futures marketturnover ever comes to physical delivery of the gold or silver represented bythe contracts traded.
Gold and silver backed securities Precious metals trading in the form of securities on exchanges is based on fixed delivery dates and transactionsizes. These forms of securitised investments include for example ExchangeTraded Funds or Exchange Traded Commodities (ETFs or ETCs) andExchange Traded Notes. ETFs, which represent equity market securities thatfollow physical commodity returns, account for around 70% of suchtrading. The value of ETFs for both silver and gold trading have increasedstrongly in recent years. These securities have had a major impact on themarket, representing over 10% of total demand in 2010. Gold ETFsholdings totalled over 60m ounces at the end of 2010. Total silver ETFholdings ended 2010 close to their peak at around 500m ounces.
Gold and silver supply and demand
Supply TheCityUK estimates that the total volume of identifiable above-ground gold at the end of 2010 was around 169,000 tonnes or 5.4bnounces. About three-quarters of this has been mined in the past 100 years.As gold is not consumed, like most commodities, virtually all of the goldthat has been mined is still in existence. Jewellery accounted for more thana half of above ground gold stocks in 2009, private investment 18%,official holdings 16% and other fabrication for most of the remainder.
The overall quantity of silver mined throughout history totalled 47bnounces. Silver's above ground supply is however only about one quarter ofthe above ground supply of gold (Chart 12) as most silver is used up forindustrial purposes. However near-market or easily mobilisable silver supplymay well exceed that of gold.
Gold supply in 2010 was at around the previous year’s levels of 135 millionounces. Mine production accounted for over 60% of the total supply. Oldgold scrap generated 38%, and net central bank sales most of theremainder.
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COMMODITIES TRADING MARCH 2011
Chart 11 Gold market global turnover
1 OTC data is three times LBMA turnover, exchange data is TOCOM, COMEX and MCX trading Source: TheCityUK estimates
Billions of ounces (bars) $bn (line)
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25Exchange tradingOTC market
20102009
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Chart 13 Volume of London bullion market clearing
Source: London Bullion Market Association
Gold, moz transferred, daily turnover average
Silver, moz transferred,daily turnover average
Gold (LH scale)
Silver (RH scale)
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Chart 12 Silver market global turnover
1 OTC data is three times LBMA turnover, exchange data is TOCOM, COMEX and MCX trading Source: TheCityUK estimates
Billions of ounces (bars)
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MARCH 2011COMMODITIES TRADING
There has been a gradual shift in production from ”traditional” goldproducing countries (South Africa, Australia, US and Canada) to“emerging” countries (China, Peru, Russia and Indonesia) over the pastdecade. Gold production in China increased by 62% between 2001 and2009 to 10 million ounces, while world output fell by 9.6% during thesame period. In 2007, China overtook South Africa to become the world’slargest gold producer. Australia overtook South Africa in 2009 to becomethe second largest producer with 7 million ounces. South Africa had beenthe biggest gold producer for more than a century. Gold annual productionin South Africa has almost halved between 2001 and 2009 to 7 millionounces.
Silver supply totalled around 770 million ounces in 2010. About 70% of theannual silver supply consists of newly mined production and most of theremainder comes from recycled above-ground stocks and net Governmentsales. The largest silver mining country in 2009 was Peru with 17% of thetotal, followed by Mexico 15%, China 13% and Australia 7%. Around 60countries mine silver annually although the bulk of production isconcentrated in 15 countries. Over the past two decades the amount ofsilver extracted from primary silver mines has fallen, while silver mined as aco-product of copper, lead, zinc, gold, or poly-metallic deposits has risen.
Demand Annual demand of both gold and silver exceeds annual mining production. The shortfall is made up from recycling metal scrap and fromcentral bank sales.
Gold demand is much harder to estimate than supply because it is widelydispersed; many buyers are deliberately secretive; and demand that is metfrom recycled scrap and demand transacted on the OTC market is difficultto measure. Identifiable physical demand increased 8% in 2009 to137million ounces. This was despite a 16% decline in fabrication demand,driven by a sharp decline in jewellery demand. Jewellery manufacturingtypically accounts for most of the gold demand, over 40% in 2009. Ageographical breakdown of gold fabrication shows that India is by far thebiggest consumer with more than a quarter. Global investment demandnearly doubled in 2009 to over 61million ounces, worth around $60bn. Thiswas largely due to fears about the global economy and financial stabilitywhich triggered a wave of safe-haven buying. Gold demand is expected bythe World Gold Council to be higher in 2010 than in 2009 as a result ofgrowing demand in India and China and sustained global demand for goldinvestment.
The status of silver is gradually changing from a precious to an industrialmetal. Demand for silver increased marginally in 2009 to 889 million ofounces and is likely to increase by more than 10% in 2010 due to anincrease in fabrication demand and investment demand which is projectedto grow to an all time high in 2010.
By far the largest use for silver is for industrial fabrication such as in theelectronics industry as silver has superior electrical conductivity. The mainconsumer countries for silver are the US, Japan, India and China. The mainfactors affecting these countries demand for silver are macro economicfactors such as economic growth, industrial production and income levels.
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Chart 14 Value of London bullion market clearing
Source: London Bullion Market Association
$bn, gold,daily turnover average
$bn, silverdaily turnover average
Gold (LH scale)
Silver (RH scale)
5
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25
20102009
20082007
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20000.0
0.5
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1.5
2.0
London gold and silverfixingsLondon gold and silver fixings are internationallypublished benchmarks for precious metals. Thesilver fixing started in 1897 and the gold fixing in1919. For gold, the market participants gettogether twice every working day for a "fixing",while a similar procedure takes place once a dayfor silver. The prices are used in contractarrangements around the world.
The fixing of the gold price is conducted bytelephone at 10:30am and 3:00pm each workingday. There are five members of the Gold Fixing, allof whom are Market Making members of theLBMA. They are the Bank of Nova Scotia–ScotiaMocatta, Barclays Bank Plc, Deutsche BankAG, HSBC Bank USA and Société Générale. Eachrepresentative keeps an open phone line to theirfirm's trading room which has orders from otherbullion banks and customers from all over theworld. The fixing lasts until a single pricerepresenting an equilibrium between supply anddemand is found. The fixing of the silver price isconducted by three Market Making members ofthe LBMA under the chairmanship of The Bank ofNova Scotia–ScotiaMocatta by telephone at 12.00noon each working day. The other two membersof the Silver Fixing are Deutsche Bank AG andHSBC Bank USA. Many gold and silver dealers andtheir customers agree in advance to use theLondon fixings as a basis for transactions.
Gold and silver ETPsaccount for77% of
investments
LONDON AS A CENTRE FOR COMMODITIESDERIVATIVES TRADINGLondon is one of the main global centres for commodities trading alongwith New York and Chicago. While Chicago is predominantly a domesticmarket London and New York source a large volume of internationalbusiness. Major derivatives exchanges located in London account foraround 15% of global trade in commodities (Table 3): NYSE.Liffe, theinternational derivatives business of Euronext which trades ‘softcommodities’; the London Metal Exchange (LME) which specialises in non-ferrous metals; and ICE Futures Europe which trades in energy products.The London Bullion Market association is the world’s largest market for OTCprecious metals trading. The UK is also home to a number of internationalcommodity organisations including the International Coffee Organisation,International Cocoa Organisation, International Sugar Organisation,International Grains Council and Grain and Feed Trade Association.
London Metal Exchange is the world’s largest exchange for non-ferrous metals with a 90% share of global trading. The LME offers futuresand traded options contracts on six primary metals: aluminium, copper,nickel, tin, lead and zinc and two aluminum alloy contracts, as well as acomposite index of these metals. Consumers as well as producers of metalsuse the official prices of LME for their long term contracts pricing. SinceMay 2005 the range of contracts traded has been widened to includeplastics contracts including polypropylene and linear low densitypolyethylene. LME also offers LMEminis, smaller-sized contracts for copper,aluminium and zinc, plus an index contract.
The primary functions of the exchange are pricing, hedging and delivery: Inorder to facilitate delivery, the LME approves storage facilities where traderscan make and take delivery. There are over 400 LME approved warehousesin over 30 locations covering the US, Europe, the Middle & the Far East.Trading on the exchange consists of open outcry trading in ‘the ring’, supported by a 24 hour telephone market and screen-based trading onLME Select. Despite its London location the LME is a global market with an international membership and with more than 95% of its business comingfrom overseas.
Turnover of LME contracts increased by 7% in 2010 to reach a record 120 million lots, equivalent to $11,600bn. Aluminium, copper and zinc were thethree largest contracts by volume with 50.1 million, 33.1 million and 18.8million lots traded respectively. Of the base metals, trading in lead saw thehighest growth rate with a 30% increase, while copper trading rose byaround a quarter.
ICE Futures Europe, a subsidiary of Intercontinental Exchange, is the leading electronic regulated futures and options exchange for global energymarkets. Energy contracts traded including crude oil, heating oil, naturalgas and unleaded gas. It is used by producers, distributors and consumersof energy to manage their price exposure in the physical energy market.Turnover grew for the thirteenth consecutive year in 2010 to reach 217million contracts or more than twice the level four years earlier. The threemost traded futures contracts were ICE Brent Crude with 100.0 millioncontracts traded during the year, followed by WTI Crude futures with 52.6million and Gas Oil contracts with 52.3 million.
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COMMODITIES TRADING MARCH 2011
Chart 15 Annual turnover of exchange-traded gold
0
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2,000
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7,000MCX
TOCOM
COMEX
2010200920082007200620052004200320022001
Source: TheCityUK estimates based on TOCOM, COMEX, MCX data
Millions of ounces $bn, (line)
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Chart 16 Annual turnover of exchange-traded silver
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70,000
80,000
90,000MCX
TOCOM
COMEX
2010200920082007200620052004200320022001
Source: TheCityUK estimates based on TOCOM, COMEX, MCX data
Millions of ounces $bn, (line)
0
500
1,000
1,500
2,000
Chart 17 Stocks of gold and silver
COMEX
Source: TheCityUK estimates
Billions of ounces
5.6 5.4
47.0
0.70
10
20
30
40
50
Stocks at end-2010Total volume mined throughout history
SilverGold
MARCH 2011COMMODITIES TRADING
NYSE.Liffe is the is the global derivatives business of the NYSE Euronextgroup. It offers a single, electronic market for products listed on itsAmsterdam, Brussels, London, Lisbon and Paris exchanges. NYSE.Liffe isEurope’s biggest exchange for ‘soft commodities’. It began trading inderivatives in 1982 and expanded to include a wide range of derivativesproducts. Derivatives markets supported by its electronic trading platform,LIFFE CONNECT, are available to customers at over 825 locations in 31countries.
In 2010 there was a total of 1,223 million contracts traded on NYSE.Liffe, ofwhich 16.7 million were in commodities. Trading in commodities on theexchange have grown steadily in recent years and more than tripled overthe past decade. Wheat milling was the most widely traded commoditycontract and accounted for 32% of commodity contracts in 2010, followedby cocoa with 27% and robusta coffee with 20%.
APX-ENDEX operates power and gas exchanges for the wholesalemarket, providing markets for short-term trading in the Netherlands, the UKand Belgium. APX-ENDEX is headquartered in Amsterdam but also hasoffices in London and Nottingham.
London Bullion Market Association (LBMA) London has thelargest market in the world for gold and silver trading, and the one with thelongest history. OTC gold and silver transactions around the world,particularly those of central banks and mining companies, are conductedthrough the "Loco London" market in which the two metals are traded fordelivery in London. The London bullion market is a wholesale market,where minimum traded amounts for clients are generally 1,000 ounces ofgold and 50,000 ounces of silver. Other centres which typically trade goldand silver “Loco London” include: in Asia, Hong Kong, Tokyo, Sydney andSingapore; in Europe, Zurich and Frankfurt; and in the US, New York. Thismarket does not require physical delivery and trades can be conducted on adeferred basis in which delivery is postponed until positions are liquidated.The “Loco London” market serves various purposes including hedging,investment and speculation.
The London gold and silver markets operate under the auspices of theLondon Bullion Market Association (LBMA). This is not an exchange. Ratherit is a representative body for the bullion market whose members includebanks, fabricators, refiners, shippers and brokers. Members of the Londonbullion market typically trade with each other and with their clients on a principal-to-principal basis. All risks, including those of credit, are betweenthe two parties to a transaction. LBMA members are classified into marketmaking members, which include all of the participants in the twice-dailyLondon gold fix as well as other bullion houses and ordinary members.
The London bullion market relies on a daily clearing system. A number ofLBMA members offer clearing services. Clearing members net out betweeneach other their own and third party gold and silver transactions so thatonly the net difference between purchases and sales is actually transferred.This system reduces the security risks and costs that would be involved inthe physical movement of bullion. A bullion clearing bank may howeveralso take physical delivery of bullion. Most bullion houses act both asbrokers for customers and as primary dealers who hold their own positions.
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Table 3Turnover of London-based derivatives exchanges
1IPE before 2005; 2Includes other Liffe exch. in Europe from 2001Source: Exchanges
20002001200220032004200520062007200820092010
ICE FuturesEurope1
25.526.430.433.335.542.192.7
138.5153.0165.7217.2
Total 223.0704.9786.0800.7895.2880.0909.9
1,179.61,315.91,333.61,560.1
LME66.459.458.672.371.978.686.992.1
113.2111.9120.3
NYSELiffe2
131.1619.1697.0695.1787.8759.3730.3949.0
1,049.71,056.01,222.6
Millions of contracts traded each yearof which
commodity 96.690.594.7112.2115.4129.2189.5243.4297.4289.7354.2
Forms of gold and silverinvestmentsBullion bars and coins are offered in a variety ofweights and sizes. These include for gold, thekilobar (32.15 troy ounces) and "London GoodDelivery" bar (400 troy ounces). Buying gold andsilver bullion coins is a popular and traditionalmeans of investing among medium and smallinvestors.
Bullion certificates A certificate of ownership canbe held by investors, instead of storing the actualbullion. Certificates allow investors to buy and sellthe security without the inconvenience associatedwith the transfer of actual physical bullion.
Accounts Some banks offer gold accounts wheregold can be bought or sold just like any foreigncurrency. Gold accounts are backed throughunallocated or allocated gold storage.
Mining shares Many investors access the preciousmetals market by investing in gold or silver miningfirms. They offer capital appreciation opportunities,as well as the opportunity to earn a dividend.
Mutual funds offer investment opportunities ingold and silver. Mutual funds diversify theirprecious metals holdings thus reducing the risk asthe investor is buying the general market riskinstead of a company-specific risk.
Bullion derivatives The precious metals derivativesmarket has grown rapidly over the past decade.Futures and options offer certain advantages suchas speculative appeal, leverage which reducescapital tie-up, no storage risk and high liquidity.
Trading on stock exchanges Gold and silver canalso be traded on the London, New York,Johannesburg and a number of other exchanges.This is a relatively recent addition to the“portfolio” of alternative investments and providesa transparent, secure and cost-effective way toinvest in gold.
They may service private clients wishing to deal in large quantities butnormally this trade would go through the client's private bank.
The London Energy Brokers Association (LEBA) is the industryAssociation representing the FSA regulated wholesale market brokers in theOTC and the exchange traded UK and liberalised European energy markets.These brokers intermediate and facilitate bilateral contracts to be concludedbetween banks, trading houses, commercial enterprises, public utilities andintegrated energy businesses, providing liquidity and price discovery tothese markets as well as contributing significant liquidity to Europeanexchange traded markets. The major products that LEBA members deal ininclude crude oil and refined petroleum products, gas, electricity andemissions.
In 2010, member firms of the London Energy Brokers’ Association, traded atotal of of 2,596,521,515MT of CO2 equivalent (CO2e) emmissionscontracts. There was also 3,044,220,988MT traded in coal contracts,9,258,799,248MWh in power contracts and 20,076,044,650MWh innatural gas contracts.
COMMODITY INVESTMENTSCommodity assets under management more than doubled between 2008and 2010 to nearly $380bn. Inflows into the sector totalled $62bn in 2010,the second highest year on record, down from the record $72bn allocatedto commodities funds in the previous year.
Commodity prices have increased sharply from the lows in late 2008 andearly 2009 at the height of the global financial crisis (Chart 2). The cost ofcereals, oil and iron ore has for example increased between 40% and150% to two year highs at the end of 2010. Prior to this, between 2003and 2008 commodity prices increased by an average of 131%, the biggestfive year increase for more than a century.
Besides the recovery in the global economy and commodity specific factors,a number of more general factors are behind the recent rise in prices.Emerging economies have driven demand for various commodities(particularly markets in China, India and the Middle East); biofuels haveboosted the demand for specific food crops; slow supply responses have amplified price pressures; and low interest rates and the weakening of thedollar have been a supporting factor.
Gold and silver prices have posted strong gains in recent years. Gold pricesincreased 29.5% in 2010 and closed the year at a record high of $1,423with an average price during the year of $1,226 per ounce. Towards theend of 2010, silver breached $30 per ounce for the first time in 30 years.The 80% rise in silver prices during the year was largely a result of stronginvestment demand.
The sharp rise of commodity prices in recent years is in contrast to the1980s and 1990s when returns on commodities were not competitive with either stocks or bonds. Commodity prices, measured in inflation adjustedterms, reached levels equivalent to their 1930s lows in 1999. Many factors have contributed to this including: falling demand for commodities as a hedge against inflation in market conditions of low inflation in developed
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COMMODITIES TRADING MARCH 2011
Chart 18 World official gold holdings
COMEX
Source: World Gold Council
% share, end-2010
Others
SwitzerlandItaly
FranceChina
Germany
US
27%
11%
3% 8%8%
39%
World total: 978 millions of ounces
3%
Chart 19 Performance of GSCI subindexes
Source: GSCI
% return, 2010
0 5 10 15 20 25 30 35
Livestock
Agriculture
Precious Metals
Industrial Metals
Energy
Total return 9.03%
34.19%
34.46%
16.73%
1.91%
10.49%
Chart 20 Annual average price of gold and silver
Source: Kitco
US dollars / troy ounce
0
100
200
300
400
500
600
700
800
900
1,000
1,100
1,200
1,300
201020052000199519900
5
10
15
20
25
Gold (LH scale)
US dollars / troy ounce
Silver (RH scale)
MARCH 2011COMMODITIES TRADING
countries; consumer spending in the U.S. which dominated global demand during the period, shifted towards services that require fewer commoditiesto produce than manufactured goods; and much higher returns on equitymarkets.
Commodity exports continue to play an important role in emerging marketeconomies although their exports have become much more diversified interms of both composition and destinations. The Middle East and NorthAfrica and to a lesser extent sub-Saharan Africa and Latin America havebeen the main beneficiaries of the recent increase in commodity prices. Fuel exports play the most critical role in the Middle East and north Africa, where they now account for more than one-third of GDP. Latin America depends on both fuel and nonfuel commodities whereas nonfuel commodities areparticularly important in sub-Saharan Africa.
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Types of commodities investmentsCommodities can be used to diversify a portfolio of financial assets (Table 4). In recent years there has been increased investment in commodities, not onlyby institutional investors, but also by hedge funds, retail investors andsovereign wealth funds. Factors that have contributed to this include: thesignificant rise in prices of many commodities; their function as a hedgeagainst inflation; economic uncertainty in global markets; underinvestment incommodities production in the past two decades; rising demand particularlyin emerging markets such as China and India; and diversification benefits. Thedevelopment of investment products that passively track a broad range ofcommodities have also made it easier for investors to access this market.
Investors can gain exposure to commodities through: direct investments in physical commodities; direct investments in commodity-related companiesand investments in commodity futures through exchange traded standardisedcontracts. Exchange traded products in particular have transformed the rangeof investment choices available in commodity markets. They are relativelyyoung compared with other commodities’ investment instruments. The firstdeveloped, the Gold ETC, was launched in 2003.
One of the simplest ways of investing in commodities is through indexedcommodity strategies. These offer access to a basket of commodities whichreduces the risk of investing as commodities themselves have low correlations.There are a number of commodity indices such as the Goldman SachsCommodities Index (GSCI), Dow Jones AIG commodity index, Deutsche BankLiquid Commodity Index (DBLCI) and the DBLCI-Mean Reversion Index,Standard & Poor’s commodity index (SPCI) and Reuters/Jefferies CRB Index.Another way of investing in commodity indexes is to invest in tilted indices,towards a certain commodity or groups of commodities. The GSCI has, forexample, six sub-indices.
Table 4Correlation of commodities and other asset classes
Source: DB Global Markets Research
1999-2009AgricultureEnergyIndustrial metalsLivestockPrecious metals
2004-2009AgricultureEnergyIndustrial metalsLivestockPrecious metals
Bonds-9.6-8.9
-13.2-8.58.4
-16.3-16.3-18.4-11.8
3.5
Correlation of S&P GSCI sub-indices with major indices
S&P 50014.413.122.510.5-2.8
22.027.527.515.6
1.7
S&PGSCI-9.6-8.9
-13.2-8.58.4
-16.3-16.3-18.4-11.8
3.5
Table 5Commodities as an asset class
Source: S&P
20105 yearSince 1999
Annual returnS&P
GSCI9.0
-6.59.9
S&P500
15.12.49.2
JPM GovtBond Index
3.43.56.8
LINKS TO OTHER SOURCES OF INFORMATION
Bank for International Settlementswww.bis.org
Ice Futures www.theice.com
Euronext.liffewww.euronext.com
Futures and Options Association www.foa.co.uk
Futures Industry Association www.futuresindustry.org
GFMS Ltdwww.gfms.co.uk
London Bullion Market Association www.lbma.org.uk
London Metal Exchangewww.lme.co.uk
The London Energy Brokers’ Associationwww.leba.org.uk
The Silver Institute www.silverinstitute.org
World Gold Councilwww.gold.org
World Trade Organisationwww.wto.org
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COMMODITIES TRADING MARCH 2011
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THECITYUK RESEARCH CENTRE:Report author: Marko Maslakovic
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