Sheptoff
Investment Group llc

Base Metals 101

Written by HardAssetsInvestor.com
April 04, 2007

Basic Bases

Gold and Silver may get all the glory, and look pretty, but when you want to build an economy, it's the base metals that steal the show. Because base metals are largely ignored as a store of wealth (unless you've got a neighbor with a zinc stockpile in his garage,) they're much better barometers of what's really happening in the world in terms of daily supply-and-demand. They respond to specific signals and industries, which means they can reward investors with either a macro economic ax to grind, or a hankering to do some deep digging (pardon the pun) on the individual markets.

For investors just getting started, here are the most widely used base metals in the world, in order of global consumption.

Steel (Iron)

The granddaddy of metals for most of the last millennium has been iron. Iron, by itself and as the major component in steel, is the most widely used metal in the world. The trouble for investors is that you can't trade it. Unless you want to buy a few freight cars worth of I-beams, there's no direct way to get exposure. This is likely to change, as the London Metal Exchange (LME) is currently working on plans for futures and OTC contracts tied to steel, but there are serious hurdles to overcome.(1) For one, the types of steel used in the markets are tremendously varied. What kinds of steel would the contracts cover? Carbon or alloy? Galvanized sheets? Cut plates? Fine grain? Atmospheric resistance? There are hundreds of variations on commodity steel as it's actually used. Fundamentally, a futures contract has to be based on a commodity definition that will be useful to suppliers and customers ... and steel producers have been deadest against the development of a steel futures contract. Until the LME and the producers figure it out, the best way for investors to access the steel markets is through steel-producing equities.

Aluminum

After steel, aluminum is the most widely used metal on the planet. It is one of the key ingredients in the rapid expansion of infrastructure around the world, and demand for aluminum is growing.

What is aluminum? It's light, pliable, rust-resistant and has high conductivity. Those features make it an incredibly important metal for industrial use, particularly for the transportation industry. Your car is mostly aluminum (and plastic), from the body to the axles and maybe even the engine. And that airplane you flew on your last business trip? Without aluminum, you wouldn't have gotten off the ground. Even those cans of soda and beer the flight attendants passed around (if you were lucky) were made from aluminum: almost a full quarter of the aluminum produced today goes into those handy little containers.

Primary aluminum is mined out of the ground as bauxite ore, changed into alumina or aluminum oxide, and then finally smelted into aluminum. Bauxite deposits are mainly found in Australia, Guinea, Brazil, and Jamaica. (At least, that was the order of production in 2000, the most recently available data) The whole process is hugely energy intensive, which means that the price of aluminum has some tie to the price of energy. Typically, smelters are located in areas with cheap energy.

Primary (new) aluminum trades on the New York Mercantile Exchange (NYMEX) with the ticker “AL” and on the London Metals Exchange (LME) as “Primary Aluminum”. Recycled aluminum is traded as “Aluminum Alloy.

Like any commodity, end users will look to substitutes if aluminum is either unavailable or excessively expensive. For electrical needs, copper can substitute for aluminum. For construction applications, composites, steel and wood can be used if prices get too high. In structural and ground transportation situations, titanium, steel and magnesium are possible substitutes. For packaging materials, plastic, paper, glass and steel can be used.(2)

Copper

Our friend copper has been around for ages. Everyone from the early Egyptians to your neighborhood plumber has relied on copper to make the world work. Today, copper is everywhere,(3) from the coins in your pocket to the plumbing in your house to the power lines and the electrical plant down the way. Even the cell phone in your pocket relies on copper for its intricate circuit board.

The largest market for copper is building construction (pipes and wires), followed by electronics and electrical products, transportation, industrial machinery and consumer products. Because of the huge demand from construction, copper prices tend to fluctuate on economic indicators such as U.S. housing starts, Chinese GDP growth and other macroeconomic reports. In 2006, China accounted for about 20 percent of the world's consumption(4) of copper, and that percentage is expected to grow. In other words, reports from The Wall St. Journal of even the smallest shifts in Asian economies can push copper prices around substantially.

Where's it come from? Chile is the big dog, producing four times the volume in copper of the number 2 group, the U.S. Peru, Australia, Indonesia, Russia are also big players, but more than anything, you need to think about Chile.(5) In 2006, global mine production was less than expected because of production problems and labor disruptions in Chile, and this kept copper at record highs. Hiccups like this are increasingly being offset by recycling, but even with the U.S. pulling 30 percent of its copper from recycling plants, copper futures remain hugely volatile.(6) Copper spot prices have gone from $0.75/lb in March 2002 to over $3/lb in March 2007. Plastic pipes anyone?

Copper trades under the ticker “HG” on the NYMEX.

Substitutions/Copper: Aluminum can be used for electrical equipment, power cables and automobile radiators. For heat exchangers, titanium and steel are used. In plumbing applications plastics are the common substitute.(7)

Zinc

The fourth most popular metal in the world's industrial beauty pageant is zinc. Like aluminum, zinc comes in two flavors: primary (about two-thirds of what's used, coming from mines) and secondary (scrap and residues). Most zinc is used as a galvanizing agent to prevent corrosion in iron and steel – those rough gray nails you used to put down your deck, your galvanized steel fishing boat, etc. The rest of the zinc (about 25 percent), is used as zinc compounds in all sorts of other stuff: paint, agricultural products, plastics, rubber and as a raw chemical in medicines and supplements. That “copper” penny in your pocket is, at least if it was minted after 1982, mostly zinc.

Really, zinc is a condiment in the industrial metals world, like salt in the kitchen. It hardly ever gets used by itself, but it spices up other metals and makes them better. Because of that, it has historically followed the price fluctuations of base metals at large, particularly copper.(8) That may, however, be changing: in 2006, zinc saw rapid price increases due to low stocks at the LME, increased world demand and tight world supply.

China, which exports a great deal of zinc, continues to wield the big stick in the market, followed by Australia, Peru and North America. Zinc can be traded on the NYMEX (LZ), at the LME (Zinc) and (as of March 26, 2007) at the Shanghai Futures Exchange (TA)(9).

Substitutions/Zinc: When looking at substitutions for zinc, you're looking to replace what zinc helps make. Plastics, steel & aluminum substitute for galvanized sheet. For corrosion protection, paint, plastic coatings and other alloy coatings are used. There are many elements that substitute for zinc in the chemical, electronic, and pigment fields.

Also Rans

The big money's in Aluminum, Copper and Zinc, but there are other metals that matter in the world economy, and three of them are traded on the futures exchanges: lead, nickel, and tin. Each is traded at the LME, though not with the same volume as the big three.

Lead, as anyone who's picked up a car battery knows, is very heavy and dense. It is also a soft and corrosion-resistant metal. While it's been abandoned in many applications due to environmental and health concerns, it’s still a major metal in global industry. The greatest use of lead is in Sealed-Lead-Acid batteries, which has seen continued growth, particularly in uses such as uninterruptible power supplies for computer applications and in machinery (like your car). It's also used in lots of smaller applications: ammunition, oxides for glass and ceramics, casting metals, sheet lead, solders, coverings and caulkings.

Behind lead is nickel. Nickel's primary use is as an additive to make stainless steel. The aerospace and power generation industries use it in combustion turbines because of its corrosion resistance, and it finds a home in batteries, coins, and other applications as well. Nickel has been much in the news recently due to supply constraints at the LME, which actually intervened in the nickel markets once when supplies got too tight. Surging demand for stainless steel in China has caused the Chinese to fire up nickel pig iron processors, which (at a relatively high cost) can create stainless steel without true nickel.

And lastly there's lowly tin. Tin's been around forever and is mined around the world, but almost half of what's used now comes from Southeast Asia. Tin is used mostly as an alloy with other metals, but also has uses as a protective coating.