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Traders cautious over steel futures

THE introduction of steel products futures in Shanghai this month is designed to give industries a hedge against sometimes wild price gyrations, but many traders are lukewarm to the new investment tool.

Ji Yong, of Hubei Province-based steel trading firm Yuanxin Material Co, said that a slump in steel prices in the second half last year made everyone in the distribution business more wary.

"Many won't dare to get involved in futures trading for the time being," Ji said. "We are not hoarding products in such weak environment, so there is not much demand there for hedging at present."

Currently it usually takes no more than five days for Yuanxin Material, which sources products from mills including Wuhan Iron & Steel Co, one of China's largest, to deliver products. The company has reduced stockpiles amid weak demand from the construction sector, Ji said.

Another Shanghai-based trader who sources steel from mills in Shanxi Province echoed the same view, citing weak markets.

"If futures trading volume is only lukewarm, the contracts won't generate much hedging opportunity," he said.

The Shanghai Futures Exchange recently won regulatory approval to launch contracts for wire rods and reinforcement bars, used mainly in construction. Trading may start later this month, several brokers said.

Analysts said that the new steel contracts, which won't be open to foreign traders, should help China gain pricing power for its products, but it would take a long time before the contracts attain status as global benchmarks.

"Futures prices initially will follow spot prices, but as turnover increases, they will eventually determine market prices," said Zeng Jiesheng, an analyst at Mysteel Research Institute.

The impact of steel futures on spot prices may be limited because physically settled futures contracts will account for only a small portion of total trading, Zeng added.

Trading volume of the new contracts in Shanghai could be as much as 10 times existing contracts for copper and zinc, given the extensive use of steel in China's economy, the China Securities Journal said.

Copper is currently the most actively traded product on the Shanghai futures bourse. China annually consumes more than 200 million tons of long steel products, which include wire rods and rebars, with a total value in excess of 60 billion yuan (US$8.8 billion). That compares with about 5 million tons for copper valued at less than 150 billion yuan, the Journal said.

A futures contract is an obligation to buy or sell a commodity or financial instrument at a specified price at a specific date. It gives both buyers and sellers a way to hedge the risk of price swings. For example, a construction company, fearing that prices may rise, can lock in a lower price for material it needs in six months and help shore up its cost structure.

Steel prices tumbled in China from a record high in June amid the global economic downturn, before bouncing back a little in recent months on expectation of infrastructure spending from the government stimulus package.

In a falling market, steel makers can lock in higher prices with futures contracts, but many mills have been reluctant to participate, analysts said.

"There are lingering fears about denting their pricing power," said Hong Yuan Securities analyst Min Dan.

Price swings

In its first official comment on steel contracts, Baoshan Iron & Steel Co, the listed unit of China's top mill, said the futures could provide a valuable hedging tool but excess speculative trading may undermine the system and contribute to wider price swings.

"Baosteel will be closely watching the progress in the steel futures," an unidentified company spokesman said via Xinhua news agency. Baosteel's products are mainly directly sold to end users, and most products are tailor-made sheets and pipes, differing from the proposed contracts on the Shanghai bourse, the official said.

The two billet contracts on the London Metal Exchange drew low turnover when they were launched a year ago. At the time, steel prices were booming, giving mills little incentive to hedge because in a rising market they could always sell for higher prices.

China initiated steel futures trading in the 1990s on several regional exchanges but halted the market after it fell prey to rampant speculation. Efforts to revive the contracts have been under way for several years at the Shanghai Futures Exchange.

Those efforts initially drew opposition from the China Iron and Steel Association, which cited the complexity of steel products and regulatory uncertainties.

Many mills feared that their ability to raise prices would be impaired. The association dropped its opposition in 2007.

"We suffered losses in futures trading in the 1990s," said Ji, of Yuanxin Material. "So we will wait and see what happens this time before getting back into that market."

Many agree that the road ahead is difficult.

"It will take a long time for the steel contracts to attain a solid footing as a hedging tool and price setter," said a Shanghai Futures Exchange official who declined to be identified. "It will take the cooperation of all stakeholders."

Another big question hanging over the futures market is the impact it will have on those existing electronic spot exchanges in China that trade steel in the form of forward transactions, the mainstay of steel trading in China.

While futures and forward contracts are both contracts to deliver a commodity on a future date at a present price, futures are exchange-traded with standardized terms whereas forwards always trade over-the-counter.

In China, forward transactions are more loosely regulated through the Ministry of Commerce.

Futures brokerages have been rushing to recruit experienced staff and clients now engaged in forward trading as they prepare for future competition, said a manager at a Shanghai-based steel forwards platform.

But forward markets aren't expected to disappear because the new steel futures cover only two products while forward transactions cover a myriad of products in the vast steel market, he said.

"Futures will have an affect but cannot replace the forwards market," Mysteel's Zeng said. "They will complement each other and develop in parallel."

Global markets including London and Dubai have introduced steel futures trading, aiming to set a benchmark for the US$800 billion industry.

In the past, global steel prices have been determined by annual negotiations between steel makers in Japan ad more lately in China and producers of steel ingredients iron ore and coking coal, such as Australia and Brazil.

The China Securities Regulatory Commission, citing the global financial crisis, said that the time is ripe for the reintroduction of steel futures, enabling China to play a bigger role in price stability efforts.

Stock market impact

Investors reacted quickly to the announcement of the new steel futures contracts by chasing stocks of steel trading firms.

Minmetals Development Co and Liangning Guoneng Group (Holding) Co shot up by the maximum allowable 10 percent on February 20, one day after the securities regulator said that it had approved the Shanghai bourse to trade steel contracts.

Steel contracts could also benefit steel makers such as Beijing Shougang Co and Maanshan Iron & Steel Co, which are expected to win extra orders after their products are registered as deliverable brands for the Shanghai contracts, according to Huatai Securities analyst Ma Keming.

But bigger mills such as Baoshan Iron & Steel Co and Angang Steel Co may benefit less because they concentrate on flat steel production and are more engaged in direct sales, he said.

Zhongchu Development Stock Co, a Beijing-based delivery warehousing company, may also get a boost from steel futures trading, according to a Guosen Securities note.

The biggest winners may be futures brokerages that will rake in commissions from the new trading. There are no directly listed futures brokerages in China; however, many are controlled by listed companies.


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