Selling (Going Short) Copper Futures to Profit from a Fall in Copper Prices

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Why copper is the metal of the future

What is copper?

Copper is a soft, malleable and ductile base metal that is known for its high thermal and electrical conductivity. It has a pinkish-orange colour, and is used as a conductor of heat and electricity, building material and as a constituent of various metal alloys.

As a native metal, copper is part of a small group of metallic elements that are usable in their organic state. It was first harnessed by humans at least 10,000 years ago and has been used to produce almost everything from coins to ornaments.

Copper is used today to manufacture a variety of products necessary for modern life, from cars to electronics. Perhaps it is because of this that copper demand has grown in line with global economic growth, making copper a reliable metal with which to track the business cycle over the long term.

Where is copper found and how is it extracted?

Copper metal is found in natural ore deposits around the globe. The metal is extracted through mining and processing. Copper is processed from ore-containing rock to its final product. As one of the highest-quality commercial metals, copper production ensures the mineral is able to find its uses in many modern-day applications.

As a mineral, copper naturally occurs throughout the earth’s crust in both sedimentary and igneous rocks. The outer 10km of the earth’s crust contains approximately 33 grams of copper for every tonne of rock. In some places, millions of years ago, volcanic activity deposited molten copper in a single location – it is here that copper extraction happens today due to the intense profitability of these areas.

Copper is extracted through the following process. The ore (containing copper) is mined from the earth and ground into powder. It is then enriched and concentrated, after which the enriched ore is roasted in air at temperatures between 500 and 700 degrees celsius. The copper-ore is then further refined by smelting it into a liquid, blowing air into it and refining it using electrolysis.

This process turns a rock containing about 0.2% copper to a copper cathode of 99.99% purity.

Modern uses of copper: What is copper used for?

Today, copper uses are abundant. These include

Building construction – copper is widely used all over the world for electrical wiring, waterproofing and plumbing of residential and commercial buildings;

Electronics – copper uses include integrated circuits, electromagnets, magnetrons, vacuum tubes, cathode ray tubes, etc.;

Transportation vehicles – copper’s strong conductivity makes it an important component in the production of electric motors;

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Consumer products – copper is a strong antimicrobial material, which is used in cookware, doorknobs, bed rails etc.;

Industrial machinery – glassmaking, printmaking and engraving equipment is also created with the help of copper;

In addition, it is used in stills for producing whisky.

Copper uses are also a stable in wiring and plumbing and are integral to appliances, heating and cooling systems and telecommunication networks. The metal is a crucial element in motors, wiring, radiators, brakes and bearings used in cars and trucks. This is becoming increasingly more true with the inception of the electric vehicle.

Copper and electric vehicles

The electric vehicles industry is rapidly changing as market leaders debut new products, battery prices fall and government incentives continue globally. As this innovative market develops, the copper industry has found a new use for the mineral. Copper is an integral element in electric vehicle technology and supporting infrastructure.

The evolving copper industry will have a considerably important impact on the demand for the metal. Copper is essential to the technology underpinning electric vehicles as it is used throughout the vehicles themselves, their charging stations and support infrastructure – due to the metal’s durability, conductivity and efficiency.

There is speculation that copper consumption is entering a new growth phase driven by a society that is increasingly becoming ‘electrified’. With the electrification of energy, it is an expectation that demand for electricity will outpace the growth in total primary energy demand in the future.

The production, distribution and transmission will require a substantial amount of copper. Specifically, the future of electronic transportation may be a mega-trend for the increase in demand for copper. This is because copper is an excellent conductor of electricity and lacks price-competitive substitutes. Currently, around 72% of copper consumption is in the power and utilities sector, and in electrical products.

With sales of electric and hybrid-electric vehicles on the rise, up 65.7% in 2020 globally, the future demand for copper and copper products is set to increase dramatically. This is further facilitated by governments around the globe who encourage the use of electric vehicles through various schemes.

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What causes movements in the price of copper?

Due to lagged delays on supply and demand data, the price of the copper commodity is driven more heavily by other factors. The economic performance of emerging markets are the main driver of copper prices. Developing economies such as China and India have an increasing demand for transportation and housing infrastructure, which raises the demand for copper.

Although there is a lag on the supply data, political unrest in South America has a huge effect on the price of copper. This is because a large amount of the global copper supply comes from countries in South America, such as Chile and Peru.

It is worth noting that, due to delayed data on supply and demand, the price of copper tends to trade more on market sentiment based on economic indicators, news and money flows in the broader economy.

Future price speculation of copper

Not only does the electric vehicle market look like its about to enter its strongest growth phase in the next 10 years, but society as a whole is becoming increasingly electrified – this means that people are relying on electricity more and more by the day.

Developments such as renewable energy are said to be a significant contributing factor, as this energy method has a higher intensity of copper consumption than conventional methods of power generation.

It is also worth noting that the consumption of copper has a twin-peak – this is where there are two peaks of copper consumption over the economic development phase. Initially, the consumption of copper in a country tends to increase in line with economic growth.

For instance, in the US and Japan, copper consumption reached its first peak at around 11 kg per capita, when gross domestic product (GDP) per capita was around the $20,000-30,000 mark. This occurs as rising demand for copper-intensive activities increases as the economy gets richer, such as investing in electric vehicles, wider electronics and infrastructure.

After such events, consumption then drops until replacement demand,caused by the need to replace existing goods, pushes it up again. The US and Japan reached the second peak at $40,000-50,000 GDP per capita. Considering that countries like China and India are yet to even reach their first peak, it is highly likely that future growth in copper will be a substantial trend.

Biggest miners of copper

When the price of copper is rising, investors in copper stock can take advantage of this through increased profits. Below is a brief explanation of some of the biggest companies in copper mining today.

Codelco is the largest of the copper miners and producers on the planet. Controlling around 19% of global copper reserves, Codelco is an autonomous company owned by the government of Chile. The company produced approximately 1.842 million metric tonnes of refined copper in 2020, roughly 11% of the world’s total, which would have been valued at $125 billion, according to late 2020 prices.

Freeport-McMoRan, founded in 1912, is the second largest copper producer in the world. Phoenix-based Freeport-McMoRan Copper & Gold Inc. is the world’s largest publicly trader copper producer. The firm’s assets include the Grasberg mining complex in Indonesia – the world’s largest copper mine in terms of reserves that are recoverable. They also own the Morenci and Safford minerals district in North America, and the Tenke Fungurume minerals district in the Democratic Republic of Congo. The company was sold to China Molybdenum for $2.65 billion at the start of 2020. In 2020 the company produced around 1.7 million metric tonnes of refined copper. Freeport-McMoRan posted revenues of $15.86 billion in 2020. The company is listed on the New York Stock Exchange (NYSE).

BHP Billiton is an Anglo-Australian international mining company and the third largest copper producer globally. BHP produced over 1.326 million metric tonnes of refined copper, and is also one of the globe’s largest producers of aluminum, silver and titanium. The company’s assets include a 57.5% interest in Minera Escondida; the largest copper-producing mine in the world. In 2020, BHP released data on its worst annual loss in history, with the company making a loss of $6.4 billion over a 12-month period. Their stock is listed on the London Stock Exchange (LSE), New York Stock Exchange (NYSE), Johannesburg Stock Exchange (JSE) and the Australian Securities Exchange (ASX).

Southern Copper, owned by the Mexican conglomerate Grupo Mexico, is one of the leading international copper mining companies. It also produces zinc, silver and lead. In 2020, Southern Copper Corp. produced 913,066 metric tonnes of copper. The firm’s major assets include the Cuajone and Toquepala mines in Peru, as well as the Cananea mine in Mexico. It is listed on the Lima Stock Exchange (BVL) and the New York Stock Exchange (NYSE).

Rio Tinto, founded in 1873, is an Australian-British international metal mining company, which is a big miner of copper. In 2020, the company produced approximately 478,000 metric tonnes of copper. The group owns a 40% share of the production from the Grasberg mine in Indonesia, which is the world’s second largest copper mine – currently owned by Freeport-McMoRan. The company is listed on the London Stock Exchange (LSE), New York Stock Exchange (NYSE) as well as the Australian Securities Exchange (ASX).

Anglo American plc is a South African production company, based in Johannesburg, and one of the world’s major copper miners. In 2020, the company produced 579,300 metric tonnes of copper. It is listed on the London Stock Exchange (LSE) and the Johannesburg Stock Exchange (JSE).

Top 10 copper mining countries

In summary

Copper has always been essential to modern society, with a vast list of extensive uses due to its price and conductivity. It is also one of the most traded commodities around the world. Its unique market has a tendency to trade on sentiment and expectation rather than fundamentals – this could be due to the time lag in the release of data on actual supply and demand.

Consequently, the price of copper tends to be correlated with economic indicators, as well as news and money flows in the broader financial market. However, with the further development of electric vehicles – and the broader electrification of society – copper looks set to have a substantial sustained increase in demand in the near-distant future.

A Guide to Understanding Opportunities and Risks in Futures Trading

Basic Trading Strategies

Dozens of different strategies and variations of strategies are employed by futures traders in pursuit of speculative profits. Here are brief descriptions and illustrations of the most basic strategies.

Buying (Going Long) to Profit from an Expected Price Increase

Someone expecting the price of a particular commodity to increase over a given period of time can seek to profit by buying futures contracts. If correct in forecasting the direction and timing of the price change, the futures contract can be sold later for the higher price, thereby yielding a profit. If the price declines rather than increases, the trade will result in a loss. Because of leverage, losses as well as gains may be larger than the initial margin deposit.

For example, assume it’s now January. The July crude oil futures price is presently quoted at $15 a barrel and over the coming month you expect the price to increase. You decide to deposit the required initial margin of $2,000 and buy one July crude oil futures contract. Further assume that by April the July crude oil futures price has risen to $16 a barrel and you decide to take your profit by selling. Since each contract is for 1,000 barrels, your $1 a barrel profit would be $1,000 less transaction costs.


Price per barrel Value of 1,000 barrel contract
January $15.00 $15,000
April
$16.00 $16,000

* For simplicity, examples do not take into account commissions and other transaction costs. These costs are important. You should be sure you understand them.

Suppose, instead, that rather than rising to $16 a barrel, the July crude oil price by April has declined to $14 and that, to avoid the possibility of further loss, you elect to sell the contract at that price. On the 1,000 barrel contract your loss would come to $1,000 plus transaction costs.

Price per barrel Value of 1,000 barrel contract
January Buy 1 July crude oil futures contract $15.00 $15,000
April Sell 1 July crude oil futures contract $14.00 $14,000
Loss $1.00 $1,000

Note that if at any time the loss on the open position had reduced funds in your margin account to below the maintenance margin level, you would have received a margin call for whatever sum was needed to restore your account to the amount of the initial margin requirement.

Selling (Going Short) to Profit from an Expected Price Decrease

The only way going short to profit from an expected price decrease differs from going long to profit from an expected price increase is the sequence of the trades. Instead of first buying a futures contract, you first sell a futures contract. If, as you expect, the price does decline, a profit can be realized by later purchasing an offsetting futures contract at the lower price. The gain per unit will be the amount by which the purchase price is below the earlier selling price. Margin requirements for selling a futures contract are the same as for buying a futures contract, and daily profits or losses are credited or debited to the account in the same way.

For example, suppose it’s August and between now and year end you expect the overall level of stock prices to decline. The S&P 500 Stock Index is currently at 1200. You deposit an initial margin of $15,000 and sell one December S&P 500 futures contract at 1200. Each one point change in the index results in a $250 per contract profit or loss. A decline of 100 points by November would thus yield a profit, before transaction costs, of $25,000 in roughly three months time. A gain of this magnitude on less than a 10 percent change in the index level is an illustration of leverage working to your advantage.

S&P 500 Index Value of Contract (Index x $250)
August Sell 1 December S&P 500 futures contract 1,200 $300,000
November Buy 1 December S&P 500 futures contract 1,100 $275,000
Profit 100 points $25,000

Assume stock prices, as measured by the S&P 500, increase rather than decrease and by the time you decide to liquidate the position in November (by making an offsetting purchase), the index has risen to 1300, the outcome would be as follows:

S&P 500 Index Value of Contract (Index x $250)
August Sell 1 December S&P 500 futures contract 1,200 $300,000
November Buy 1 December S&P 500 futures contract 1,300 $325,000
Loss 100 points $25,000

A loss of this magnitude ($25,000, which is far in excess of your $15,000 initial margin deposit) on less than a 10 percent change in the index level is an illustration of leverage working to your disadvantage. It’s the other edge of the sword.

While most speculative futures transactions involve a simple purchase of futures contracts to profit from an expected price increase — or an equally simple sale to profit from an expected price decrease — numerous other possible strategies exist. Spreads are one example.

A spread involves buying one futures contract in one month and selling another futures contract in a different month. The purpose is to profit from an expected change in the relationship between the purchase price of one and the selling price of the other.

As an illustration, assume it’s now November, that the March wheat futures price is presently $3.50 a bushel and the May wheat futures price is presently $3.55 a bushel, a difference of 5¢. Your analysis of market conditions indicates that, over the next few months, the price difference between the two contracts should widen to become greater than 5¢. To profit if you are right, you could sell the March futures contract (the lower priced contract) and buy the May futures contract (the higher priced contract).

Assume time and events prove you right and that, by February, the March futures price has risen to $3.60 and the May futures price is $3.75, a difference of 15¢. By liquidating both contracts at this time, you can realize a net gain of 10¢ a bushel. Since each contract is 5,000 bushels, the net gain is $500.

November Sell March wheat @ $3.50 bushel Buy May wheat @ $3.55 bushel Spread 5c
February Buy March wheat @ $3.60 bushel Sell May wheat @ $3.75 bushel Spread 15c
$.10 loss $.20 gain

Net gain 10¢ bushel
Gain on 5,000 bushel contract $500

Shareholders

Stock markets are measured by stock indexes (or indices), such as the Dow Jones Industrial Average (DJIA) in New York, and the FTSE 100 index (often called the Footsie) in London. These indexes show changes in the average prices of a selected group of important stocks. There have been several stock market crashes when these indexes have fallen considerably on a single day (e.g. ‘Black Monday 5 , 19 October 1987, when the DJIA lost 22.6%).

Financial journalists use some animal names to describe investors:

■ bulls are investors who expect prices to rise

■ bears are investors who expect them to fall

■ stags are investors who buy new share issues hoping that they will be over-subscribed. This means they hope there will be more demand than available stocks, so the successful buyers can immediately sell their stocks at a profit.

A period when most of the stocks on a market rise is called a bull market. A period when most of them fall in value is a bear market.

Dividends and capital gains

Companies that make a profit either pay a dividend to their stockholders, or retain their earnings by keeping the profits in the company, which causes the value of the stocks to rise. Stockholders can then make a capital gain – increase the amount of money they have – by selling their stocks at a higher price than they paid for them. Some stockholders prefer not to receive dividends, because the tax they pay on capital gains is lower than the income tax they pay on dividends. When an investor buys shares on the secondary market they are either cum div, meaning the investor will receive the next dividend the company pays, or ex div, meaning they will not. Cum div share prices are higher, as they include the estimated value of the coming dividend.

Institutional investors generally keep stocks for a long period, but there are also speculators – people who buy and sell shares rapidly, hoping to make a profit. These include day traders – people who buy stocks and sell them again before the settlement day. This is the day on which they have to pay for the stocks they have purchased, usually three business days after the trade was made. If day traders sell at a profit before settlement day, they never have to pay for their shares. Day traders usually work with online brokers on the internet, who charge low commissions – fees for buying or selling stocks for customers. Speculators who expect a price to fall can take a short position, which means agreeing to sell stocks in the future at their current price, before they actually own them. They then wait for the price to fall before buying and selling the stocks. The opposite – a long position – means actually owning a security or other asset: that is buying it and having it recorded in one’s account.

June 1: Sell 1,000 Microsoft stocks, to be delivered June 4, at current market price: $26.20 June 3: Stock falls to $25.90. Buy 1,000

June 4: Settlement day. Pay for 1,000 stocks @ $25.90, receive 1,000 x $26.20. Profit $300

A short position

31.1 Label the graph with words from the box. Look at A opposite to help you.

bull market crash

1984 1985 1986 1987 1988

31.2 Answer the questions. Look at A, B and C opposite to help you.

1 How do stags make a profit?

2 Why do some investors prefer not to receive dividends?

3 How do you make a profit from a short position?

31.3 Make word combinations using a word or phrase from each box. Some words can be used twice. Then use the correct forms of the word combinations to complete the sentences below. Look at B and C opposite to help you.

make a capital gain
own a dividend
pay earnings
receive a position
retain a profit
take securities
tax

1 I. less. on capital gains

than on income. So as a shareholder, I prefer

not to. a. If the

company. its. , I can

selling my shares at a profit instead.

2 Day trading is exciting because if a share price

falls, you can. a. by

. a short. But it’s risky

Would you like to be

selling. that you don’t even

The sculpture of a bull near the New York Stock Exchange

a day trader? Or would you be frightened of taking such risks?

Influences on share prices

Share prices depend on a number of factors:

■ the financial situation of the company

■ the situation of the industry in which the company operates

■ the state of the economy in general

■ the beliefs of investors – whether they believe the share price will rise or fall, and whether they believe other investors will think this.

Prices can go up or down and the question for investors – and speculators – is: can these price changes be predicted, or seen in advance? When price-sensitive information – news that affects a company’s value – arrives, a share price will change. But no one knows when or what that information will be. So information about past prices will not tell you what tomorrow’s price will be.

There are different theories about whether share price changes can be predicted.

■ The random walk hypothesis. Prices move along a ‘random walk’ – this means day-to­day changes arc completely random or unpredictable.

■ The efficient market hypothesis. Share prices always accurately or exactly reflect all relevant information. It is therefore a waste of time to attempt to discover patterns or trends – general changes in behaviour – in price movements.

Head and shoulders pattern

■ Technical analysis. Technical analysts are people who believe that studying past share prices does allow them to forecast future price changes. They believe that market prices result from the psychology of investors rather than from real economic values, so they look for trends in buying and selling behaviour, such as the c head and shoulders’ pattern.

■ Fundamental analysis. This is the opposite of technical analysis: it ignores the behaviour of investors and assumes that a share has a true or correct value, which might be different from its stock market value. This means that markets are not efficient. The true value reflects the present value of the future income from dividends.

Analysts distinguish between systematic risk and unsystematic risk. Unsystematic risks are things that affect individual companies, such as production problems or a sudden fall in sales. Investors can reduce these by having a diversified portfolio: buying lots of different types of securities. Systematic risks, however, cannot be eliminated in this way. For example market risk cannot be avoided by diversification: if a stock market falls, all the shares listed on it will fall to some extent.

32.1 Match the two parts of the sentences. Look at A and B opposite to help you.

1 The random walk theory states that

2 The efficient market hypothesis is that

3 Technical analysts believe that

4 Fundamental analysts believe that

a studying charts of past stock prices allows you to predict future changes,

b stocks are correctly priced so it is impossible to make a profit by finding undervalued ones,

c you can calculate a stock’s true value, which might not be the same as its market price,

d it is impossible to predict future changes in stock prices.

32.2 Are the following statements true or false? Find reasons for your answers in B and C opposite.

1 Fundamental analysts think that stock prices depend on psychological factors – what people think and feci – rather than pure economic data.

2 Fundamental analysts say that the true value of a stock is all the income it will bring an investor in the future, measured at today’s money values.

3 Investors can protect themselves against unknown, unsystematic risks by having a broad collection of different investments.

4 Unsystematic risks can affect an investor’s entire portfolio.

32.3 Match the theories (1-3) to the statements (a-c). Look at B opposite to help you.

1 fundamental analysis

2 technical analysis

3 efficient market hypothesis

Share prices are correct at any given time. When new information appears,

they change to a new correct price.

By analysing a company, you can determine its real value. This sometimes allows you to make a profit by buying underpriced shares.

It’s not only the facts about a company that matter: the stock price also depends on what investors think or feel about the company’s future.

Do you believe that it is possible to find undervalued stocks, predict future price and regularly get returns that are higher than the stock market average?

Government and corporate bonds

Bonds are loans to local and national governments and to large companies. The holders of bonds generally receive fixed interest payments, once or twice a year, and get their money – known as the principal – back on a given maturity date. This is the date when the loan ends.

Governments issue bonds to raise money and they are considered to be a risk-free investment. In Britain government bonds are known as gilt-edged stock or just gilts. In the US they are called Treasury notes, which have a maturity of 2-10 years, and Treasury bonds, which have a maturity of 10-30 years. (There are also short-term Treasury bills which have a different function: see Units 25 and 27.)

Companies issue bonds, called corporate bonds, because they can usually pay less interest to bondholders than they would have to pay if they raised the same money by a bank loan. These bonds are generally safer than shares, because if a company cannot repay its debts it can be declared bankrupt. If this happens, the creditors can force the company to stop doing business, and sell its assets to repay them. In this way, bondholders will probably get some of their money back.

Borrowers – the companies issuing bonds – are given credit ratings by credit agencies such as Standard & Poor’s and Moody’s. This means that they are graded, or rated, according to their ability to repay the loan to the bondholders. The highest grade (AAA or Aaa) means that there is almost no risk that the borrower will default – fail to pay interest or to repay the principal. Lower grades (e.g. Baa, BBB, C, etc.) mean an increasing risk of the borrower becoming insolvent – unable to pay interest or repay the capital.

Prices and yields

Bonds are traded by banks which act as market makers for their customers, quoting bid and offer prices with a very small spread or difference between them. (See Unit 30) The price of bonds varies inversely with interest rates. This means that if interest rates rise, so that new borrowers have to pay a higher rate, existing bonds lose value. If interest rates fall, existing bonds paying a higher interest rate than the market rate increase in value. Consequently the yield of a bond – how much income it gives – depends on its purchase price as well as its coupon or interest rate. There are also floating-rate notes – bonds whose interest rate varies with market interest rates.

Other types of bonds

When interest rates are high, some companies issue convertible shares or convertibles, which are bonds that the owner can later change into shares. Convertibles pay lower interest rates than ordinary bonds, because the buyer gets the chance of making a profit with the convertible option.

There are also zero coupon bonds that pay no interest but are sold at a big discount on their par value, which is 100%, and repaid at 100% at maturity. Because they pay no interest, their owners don’t receive money every year (and so don’t have to decide how to reinvest it); instead they make a capital gain at maturity.

Bonds with a low credit rating (and a high chance of default), but paying a high interest rate, are called junk bonds. Some of these are known as fallen angels – bonds of companies that were previously in a good financial situation, while others are issued to finance leveraged buyouts. (See Unit 40)

BrE: convertible share; AmE: convertible bond

33.1 Match the words in the box with the definitions below. Look at A and B opposite to help you.

coupon maturity date
credit rating principal
gilt-edged stock Treasury bonds
default Treasury notes
insolvent yield

1 the amount of capital making up a loan

2 an estimation of a borrower’s solvency or ability to pay debts

3 bonds issued by the British government

4 non-payment of interest or a loan at the scheduled time

5 the day when a bond has to be repaid

6 long-term bonds issued by the American government

7 the amount of interest that a bond pays

8 medium-term (2-10 year) bonds issued by the American government

9 the rate of income an investor receives from a security 10 unable to pay debts

33.2 Are the following statements true or false? Find reasons for your answers in A, B and C opposite.

1 Bonds are repaid at 100% when they mature, unless the borrower is insolvent.

2 Bondholders are guaranteed to get all their money back if a company goes bankrupt.

3 AAA bonds are a very safe investment.

4 A bond paying 5% interest would gain in value if interest rates rose to 6%.

5 The price of floating-rate notes doesn’t vary very much, because they always pay market interest rates.

6 The owners of convertibles have to change them into shares.

7 Some bonds do not pay interest, but are repaid at above their selling price.

8 Junk bonds have a high credit rating, and a relatively low chance of default.

33.3 Answer the questions. Look at A, B and C opposite to help you.

1 Which is the safest for an investor?

A a corporate bond B a junk bond C a government bond

2 Which is the cheapest way for a company to raise money?

A a bank loan B an ordinary bond C a convertible

3 Which gives the highest potential return to an investor?

A a corporate bond B a junk bond C a government bond

4 Which is the most profitable for an investor if interest rates rise?

A a Treasury bond B a floating-rate note C a Treasury note

Is this a good time to buy bonds? Why/why not?

Forward and futures contracts are agreements to sell an asset at a fixed price on a fixed date in the future. Futures are traded on a wide range of agricultural products (including wheat, maize, soybeans, pork, beef, sugar, tea, coffee, cocoa and orange juice), industrial metals (aluminium, copper, lead, nickel and zinc), precious metals (gold, silver, platinum and palladium) and oil. These products are known as commodities. Futures were invented to enable regular buyers and sellers of commodities to protect themselves against losses or to hedge against future changes in the price. If they both agree to hedge, the seller (e.g. an orange grower) is protected from a fall in price and the buyer (e.g. an orange juice manufacturer) is protected from a rise in price.

Futures are standardized contracts – contracts which are for fixed quantities (such as one ton of copper or 100 ounces of gold) and fixed time periods (normally three, six or nine months) – that are traded on a special exchange. Forwards are individual, non- standardized contracts between two parties, traded over-the-counter – directly, between two companies or financial institutions, rather than through an exchange. The futures price for a commodity is normally higher than its spot price – the price that would be paid for immediate delivery. Sometimes, however, short-term demand pushes the spot price above the future price. This is called backwardation.

Futures and forwards are also used by speculators – people who hope to profit from price changes.

More recently, financial futures have been developed. These are standardized contracts, traded on exchanges, to buy and sell financial assets. Financial assets such as currencies, interest rates, stocks and stock market indexes fluctuate – continuously vary – so financial futures are used to fix a value for a specified future date (e.g. sell euros for dollars at a rate of € 1 for $1.20 on June 30).

■ Currency futures and forwards are contracts that specify the price at which a certain currency will be bought or sold on a specified date.

■ Interest rate futures are agreements between banks and investors and companies to issue fixed income securities (bonds, certificates of deposit, money market deposits, etc.) at a future date.

■ Stock futures fix a price for a stock and stock index futures fix a value for an index (e.g. the Dow Jones or the FTSE) on a certain date. They are alternatives to buying the stocks or shares themselves.

Like futures for physical commodities, financial futures can be used both to hedge and to speculate. Obviously the buyer and seller of a financial future have different opinions about what will happen to exchange rates, interest rates and stock prices. They are both taking an unlimited risk, because there could be huge changes in rates and prices during the period of the contract. Futures trading is a zero-sum game, because the amount of money gained by one party will be the same as the sum lost by the other.

34.1 Match the words in the box with the definitions below. Look at A opposite to help you

backwardation commodities forwards futures
to hedge over-the-counter spot price

1 the price for the immediate purchase and delivery of a commodity

2 the situation when the current price is higher than the future price

3 adjective describing a contract made between two businesses, not using an exchange

4 contracts for non-standardized quantities or time periods

5 physical substances, such as food, fuel and metals, that can be bought or sold with futures contracts

6 to protect yourself against loss

7 contracts to buy or sell standardized quantities

34.2 Complete the sentences using a word or phrase from each box. Look at A and B opposite to help you.

u banks v companies w farmers

A Commodity futures allow B Interest rate futures allow C Currency futures allow

x food manufacturers y importers z investors

1 to charge a consistent price for their products.

2 to be sure of the rate they will get on bonds which could be

issued at a different rate in the future.

3 to know at what price they can borrow money to finance

4 to make plans knowing what price they will get for their crops.

5 to offer fixed lending rates.

6 . to remove exchange rate risks from future international

34.3 Are the following statements true or false? Find reasons for your answers in B opposite.

1 Financial futures were created because exchange rates, interest rates and stock prices all regularly change.

2 Interest rate futures are related to stocks and shares.

3 Financial futures contracts allow companies to protect themselves against short-term changes in exchange rates.

4 You can only hedge if someone who expects a price to move in the opposite direction is willing to buy or sell a contract.

5 Both parties can make money out of the same futures contract.

Look at some commodity prices, and decide if you think they will rise or fall over the next three months. Check in three months 1 time to see if you would have made or lost money by buying or selling futures.

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