The LME, warehousing and the lead market

The LME, warehousing and the lead market Metal Bulletin s 5 th Lead Conference Istanbul 20 th March 2013 Duncan Hobbs +44 20 3037 4497 duncan.hobbs@macquarie.com In preparing this research, we did not take into account the investment objectives, financial situation and particular needs of the reader. Before making an investment decision on the basis of this research, the reader needs to consider, with or without the assistance of an adviser, whether the advice is appropriate in light of their particular investment needs, objectives and financial circumstances. Please see disclaimer. 1

2 The LME, warehousing and the lead market What s been happening in the lead market lately? LME lead price, forward curve and metal premiums LME metals warehousing load out rates and locations The distribution of stocks across LME warehouses and carry trades LME warehousing what changes could be made? LME warehousing what s the impact on the lead market?

3 LME lead price largely range bound over the last 18 months but still trading at historically high levels US$/tonne 3,000 2,800 2,600 2,400 2,200 2,000 1,800 LME lead prices Annual average, US$/tonne 3,000 2,500 2,000 1,500 1,000 500 549 631 774 624 528 502 454 476 453 516 888 976 1,287 2,595 2,085 1,726 2,148 2,398 2,061 2,330 1,600 O 2011 A 2012 O 2012 J 2013 0 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: LME, Macquarie Research, March 2013. Note: 2013 average price is for year-to-date and not a forecast for the year as a whole

4 Spot lead premiums have spiked in the last year. Contract premiums reportedly up sharply in 2013 Lead ingot spot premiums LME lead price : premium ratios 500 25% 400 20% US$/tonne 300 200 USA del. Eur EXW Singapore % LME price 15% 10% 100 5% 0 0% A 2011 O 2011 A 2012 O 2012 J 2013 A 2011 O 2011 A 2012 O 2012 J 2013 Singapore USA del. Eur EXW Source: CRU, LME, Macquarie Research, March 2013. Note: premiums for secondary lead ingot

5 Lead scrap price has risen sharply as proportion of LME lead price LME lead and scrap lead prices 80% 3,000 70% 2,500 3MMA, % LME lead price 60% 50% 40% 30% 20% US$/tonne 2,000 1,500 1,000 10% 500 0% 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004 2005 2006 2007 2008 2009 2010 2011 2012 LME lead Lead scrap Source: CRU, LME, Macquarie Research, March 2013. Note: scrap prices basis average of US and European markets for lead content of whole drained batteries

6 Lead prices used to fall when stocks rose but stock-to-price relationship has now broken down LME lead price, commercial stocks Lead price and stock-to-cons. ratio LHS: price RHS: stocks 5,000 4,000 800 3,500 700 4,000 Price, US$/tonne 3,000 2,500 2,000 1,500 1,000 600 500 400 300 200 Stocks, '000 tonnes Real price, US$/tonne 3,000 2,000 1,000 2001-10 2011 2012 2013 Feb 2013 500 100 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 0 0 0 1 2 3 4 5 Stocks in weeks of world cons. Source: CRU, ILZSG, LME, Macquarie Research, March 2013. Note: all price data are month average cash LME. In right hand chart real prices are in 2012 USD

7 LME lead price and forward curve In principle the natural shape of the forward price curve for any durable commodity, such as lead metal, is a contango (forward price > cash price) equal to the cost of carry i.e. costs of holding stock The forward price is not a forecast Costs of holding stock are financing (or opportunity cost), storage and insurance Where contango is less than cost of carry, or more obviously where forward price is in backwardation, there is incentive to sell promptly and reduce stock holdings Where contango is greater than cost of carry there is opportunity to accumulate and hold stocks for a profit

8 Physical premium for base metals Physical premium for base metals, including lead, is the amount over the LME price a buyer is prepared to pay for physical purchase and possession of metal Physical premiums are a function of (1) product form; (2) producer brand; (3) parcel size; (4) delivery date and location; (5) payment terms; (6) Incoterms In principle the premium is to cover supplier s costs in physically providing metal to buyer In practice premium can and does fluctuate according to the balance between physical supply of metal available to buy and physical demand for metal in the market at any point in time

LME warehouse rules affect (lack of) access to stock load out rates and location, location, location!! LME approved warehouses must deliver out minimum daily volumes of stock on demand (which become de facto market maximums) Load out rates apply to aluminium, copper, lead and zinc in aggregate not individually (nickel and tin are handled separately) The rates apply per warehousing company per location per working day but do not vary with the number of warehousing units LME warehouse load out rates Total metal stocks (tonnes) Less than 300,000... Min. load out rate (tonnes / day)...1,500 300,000 599,999......2,000 600,000 899,999......2,500 900,000 and over...3,000... From 1 April, where there are critical queues for any one metal, another 500tpd minimum of other metal must be delivered on demand 9 Source: LME, Macquarie Research, March 2013. Note: excluding nickel and tin

10 Lead and other metal markets may be in surplus but consumer access to stocks can be limited by 1. The distribution of stocks across LME warehousing locations in the context of limited load out rates 2. Competition from investors for metal to place in carry trades i.e. stock holding funded by forward price contango, and encouraged by rising premiums

11 LME lead stocks increase sharply in recession; recently concentrated in specific locations LME lead stocks and cancellations LME lead stocks by location 400 200 '000 tonnes 300 200 Cancelled On warrant '000 tonnes 150 100 ANT VLI PKL JHB DET 100 50 ROW 0 0 J 2009 J 2009 J 2010 J 2010 J 2013 J 2009 J 2009 J 2010 J 2010 J 2013 Large LME lead stocks cancellations starting first half of last year followed by some redeliveries into new locations; ROW stocks drop sharply, total still high Some stocks reportedly withdrawn to meet industrial demand, especially in USA Source: LME, Macquarie Research, March 2013

12 Latest LME lead stocks by location LME lead stocks top ten locations ANT ANT 26% VLI PKL JHB DET VLI PKL JHB DET 18% 17% 17% 17% BCN BIL LGB GEN LAX BCN BIL LGB GEN LAX 2% 2% 0% 0% 0% 0 20 40 60 80 '000 tonnes 0% 5% 10% 15% 20% 25% 30% % of total Source: LME, Macquarie Research, March 2013. Note: data as of 14 March 2013

13 LME metal stocks large proportion held in small number of locations LME metal stocks top ten locations VLI VLI 24% DET DET 22% NOL NOL 13% RTM RTM 10% SNG SNG 8% ANT BWI JHB ANT BWI JHB 4% 5% 6% TRI MOB TRI MOB 2% 2% 0 500 1,000 1,500 2,000 '000 tonnes 0% 5% 10% 15% 20% 25% % of total Source: LME, Macquarie Research, March 2013. Note: excluding nickel, tin, cobalt and molybdenum as of 14 March 2013

14 LME listed warehouses long queues in some locations, underpinning metal premiums How many days might it take to withdraw metal from key LME warehouse locations? Days to withdraw all metal stocks Days to withdraw next lead unit VLI 755 DET 510 DET 700 VLI 448 NOL 478 ANT 146 RTM 397 JHB 41 SNG 342 TRI 18 ANT 256 PKL 17 BWI JHB TRI 94 175 225 BIL RTM LGB 10 6 1 New LME will change access to lead stocks in three of the five main locations: ANT, DET, VLI MOB 84 LAX 1 0 200 400 600 800 Working days 0 100 200 300 400 500 600 Working days Source: LME, Macquarie Research, March 2013. Note: maximum days to withdraw assuming all metal is held by a single warehousing company in each location as of 14 March

15 Key factors in stock carries Libor interest rates have fallen, facilitating contango funded stock carry trades Headline LME warehouses rents have continued to rise in recent years but actual storage fees charge can, and do, vary with contangos Metal can also be stored in private warehouses, on site at smelters or in transit

16 Lead stock carry trade out of money for most of last two years, unless at low rent and / or premium added Indicative margins on lead stock carry trades over three months 50 25 Profit 100 Profit 0 50 US$/tonne -25-50 -75-100 -125-150 Loss Warehouse at cost 50% LME rent Full LME rent 0-50 -100-150 J 2009 J 2009 J 2010 J 2010 J 2013 J 2009 J 2009 J 2010 J 2010 J 2013 US$/tonne Loss Financing plus premium Financing only 50% LME rent Source: BBA, LME, Macquarie Research, March 2013. Note: calculations basis cash-to-three month spread and funding at 3M USD Libor plus 100bps. Warehouse at cost assumed to be 5 / tonne / day. Full LME rent based on average of all warehouses approved for lead; 40 / tonne / day in FY2013. Premium contribution calculated basis three-month rolling change in NW European spot secondary ingot premium

17 Lead stock carries have been plainly less profitable than aluminium carries over most of last two years Indicative margins on lead stock carries over three months 50 25 Profit 0 US$/tonne -25-50 -75-100 -125 J 2009 M 2009 M 2009 J 2009 S 2009 N 2009 J 2010 M 2010 M 2010 J 2010 S 2010 N 2010 M 2011 M 2011 S 2011 N 2011 M 2012 M 2012 S 2012 N 2012 J 2013 M 2013 Aluminium Lead Loss Source: BBA, LME, Macquarie Research, March 2013. Note: calculations basis cash-to-three month spread and funding at 3M USD Libor plus 100bps. Storage cost assumed to be 50% of LME official rent based on average of all warehouses approved for aluminium and lead; 44.5 and 40 / tonne / day, respectively, in FY2013

18 LME metals most involved in carry trades have under-performed peers, reflecting fundamentals 350 LME base metals price indices Aluminium is the metal most involved in stock carry trades, followed by zinc Index Jan 2009 = 100 300 250 200 150 100 50 Cu Sn Pb Zn Ni Al Aluminium s price performance has been poorest of all the metals on the LME since 2009 Aluminium has run heaviest surplus relative to market size since 2009 Zinc price has also underperformed and market has run sizable surplus 0 J 2009 J 2009 J 2010 J 2010 J 2013 Copper, lead prices outperformed; market balances have been tighter Source: LME, Macquarie Research, March 2013. Note: LME price indices are based on month average cash settlement prices

19 What s keeping forward price curves in contango (most of the time)? LME warrants allocated at seller s option Typically no one wants cash metal that is, typically no one wants to take physical delivery of metal stuck at the back of a long queue paying full rent with the result that forward prices remain better bid than prompt Increasing influence of index fund money, which requires regular rolls, supporting forward prices Forward buying by large industrial consumers

20 LME warehousing what changes could be made? Link load out rates to the number of individual units warehousing companies operate in any one location Different load out rates for different transport modes (road, rail, sea) Separate queues for each metal (LME will step this way with new rule from 1 st April) Delist certain warehousing locations for new deliveries of certain metals Cap amount of metal a warehousing company can hold in any one location Reduce rents payable while metal is waiting in a queue to leave a warehouse Any change should be carefully considered to avoid unintended consequences

21 LME metal stock carry trades how could it all end? LME rule change(s) Potentially high impact but low probability in our view A rise in interest rates and / or warehouse storage costs Impact depends on how spreads respond and, in any case, an increase in interest rates appears a distant prospect at this time An increase in the opportunity cost of capital Prime candidate in our view Banks with warehousing companies may come under regulatory pressure to sell Impact depends on timing / terms Metals markets move into deficit, stocks drawn down to fill shortfall Happy ending but wishful thinking?!

22 LME warehousing what s been the impact on the lead market? Lead cannot be considered in isolation it s total stock holdings that matter In terms of market analysis, fundamentals alone are insufficient financial factors matter too Consumers are facing competition from investors / traders for metal units The LME, intended in principle to be market of last resort, in practice, appears to be a market of first resort for producers and of no resort for consumers in some circumstances This has contributed to high and rising premiums in some metals markets, although in lead the principal driver appears to have been a scramble for scrap, pushing scrap prices to record levels Exchange prices appear to reflect market fundamentals as well as queues

23 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return > 3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return > 3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield. Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected <-10% Macquarie First South - South Africa Outperform return > 10% in excess of benchmark return Neutral return within 10% of benchmark return Underperform return > 10% below benchmark return Macquarie - Canada Outperform return > 5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return > 5% below benchmark return Macquarie - USA Outperform return > 5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return > 5% below benchmark return Volatility index definition* This is calculated from the volatility of historic price movements. Very high highest risk Stock should be expected to move up or down 60-100% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40-60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30-40% in a year. Low medium stock should be expected to move up or down at least 25-30% in a year. Low stock should be expected to move up or down at least 15-25% in a year. * Applicable to Australian/NZ stocks only Recommendation 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit /efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions for quarter ending 31 December 2012 AU/NZ Asia RSA USA CA EUR Outperform 47.87% 54.89% 54.41% 41.93% 60.86% 44.14% (for US coverage by MCUSA, 6.10% of stocks covered are investment banking clients) Neutral 37.94% 26.41% 38.24% 52.16% 33.70% 27.73% (for US coverage by MCUSA, 4.91% of stocks covered are investment banking clients) Underperform 14.19% 18.70% 7.35% 5.91% 5.44% 28.13% (for US coverage by MCUSA, 3.33% of stocks covered are investment banking clients)

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