Commodities & Futures: Future of new alloy contract in the balance

THERE was a buzz of unfamiliar accents in the London Metal Exchange last Tuesday. The new aluminium alloy futures contract was being launched, and the metal brokers had invited some of the suppliers and end-users to see how the guys with the telephones and funny hand movements did their business. The overwhelming accent was West Midlands, which was probably comforting to the people in the City, who did not know anything was still made there.

From the market's point of view the new contract is interesting. It is the first time a contract in a processed, as opposed to basic, metal has been traded. The raw material comes from scrap: from factory offcuts, from bits of cars, washing machines or whatever. It is processed by aluminium foundries, and bought by die-casting companies. Much of the cast product will end up being used once again in cars.

The price of alloy has weakened in the past three years. LM6, a good quality alloy, peaked at about pounds 1,200 a tonne in 1989 and has now dropped to about pounds 900. The collapse of sterling has pushed the price up by about pounds 50, while the recession has had a double-edged effect: while it has reduced demand, it has also reduced supply, because factories are producing less scrap. This is not just a recessionary phenomenon; factories have in general become much less profligate with their metal. The market thus has a complex supply as well as demand element.

No-one is prepared to bet on how well the contract will work. While the brokers and traders will probably do well out of it, there is great uncertainty among the men from the Black Country. Foundries that are short of work (of which there are plenty) will not be complaining in the short run, for it gives them a new market for their product. When the warehouses are opened up on 6 January, the end of the first three-month contract, there will probably be plenty of ingots in them.

Whether there will be genuine industrial demand for the ingots is another matter, however. They will be of three grades, corresponding to basic Japanese, American and European standards. But, one die-caster says, 'no-one in this country will use them'. They are low quality, and will need to be melted down and reformulated before they can be sold to an end-user. 'Why should anyone buy a metal out of a warehouse that might have been there for years when he can get what he wants made down the road?' he asks.

He is also sceptical that the contract will reduce volatility in the market, as advertised. While agreeing that alloy is a relatively volatile metal, he says the current system, under which motor manufacturers - the main end-users of alloy - agree to adjust the price every month is quite satisfactory.

He suspects that the new contract will in general push the price up, while fuelling the volatility. 'Why do we need a market where prices can be manipulated by speculators who might send them up or down by pounds 50 in a day?' he asks. 'If somebody locks into a price that it is pounds 50 higher than it would have been, he may have stability but at what price?' He adds: 'Anything that puts up the price of alloy puts up the price of the car.'

Ralph Kestenbaum, chairman of the LME's aluminium alloy committee, responds that all this is to miss the point of the exchange. He points out that 'the LME does not set itself up as a supplier. It is basically to be used for quotation purposes.' He acknowledges that there must be genuine demand for the ingots, however, and believes there will be. 'About 80 per cent of the Japanese who import the standard JIS Japanese alloy remelt it and cook it up with extra pepper and salt.'

He also rejects the charge that there will be extra volatility. 'There may seem to be, but that is because there is more transparency.' Industrial prices go up and down because discounts are cut and increased, even if the published price is not changed.

On 6 January, we will get a clue as to whether the market will work. Despite his objections to the contract, the die-caster thinks it probably will, because of the skills of the LME. If it does, the alloy market will have a new reference point: the pages of Metal Bulletin will be a little less heavily thumbed. We shall have to wait a littler longer to find out if we will also have to pay more for our cars as a result.

(Photographs omitted)