Category: Commodity Futures

Fashion and clothing is one of the most important industries globally, accounting for a major contribution to the economies. Despite being seen by many as an industry that is frivolous and indulgent, the global clothing and apparel industry is a serious contender nonetheless.

Cotton as a commodity is one of the most important raw material that is central to the fashion industry, the clothing and apparel market at large. Cotton is also a commodity that is traded as a futures product that is standardized and cleared at an exchange.

The relationship between a futures commodity such as that of cotton, and the retail sector is often debated and widely covered. Therefore, it is common to find someone asking the question whether futures prices have an impact on the end product where it is used.

In the context of this article, it is interesting to learn how the price of cotton futures can influence or impact the price of clothing in the retail sector and the fashion and clothing industry at large.

Due to the fact that the futures asset that is traded reflects in part the actual supply and demand of the product in question, the rising or falling prices has some kind of impact on the final end product without a doubt. The question is how much of an impact the raw material has.

For example, one of the easiest relationships to ascertain between the futures markets and the retail world is the crude oil or even the gasoline futures prices.

Although the prices reflected in the respective futures commodities represent the commodity as the raw material, the end result (the fuel used at the gas stations) has a relationship with the futures prices as it is only one of the input costs.

The final costs are of course determined by other variables such as taxes, demand, distribution and so on, with of course, the price of the raw material contributing to the influence on the final pricing as well.

To truly understand how cotton futures have an impact on the global apparel industry, it is important to look at the factors that influence the prices of the cotton futures which are responsible for the overall impact on the industry.

Overview of the global apparel market

The apparel market is valued at $3 trillion according to data from FashionUnited which is said to account for nearly 2% of the global Gross Domestic Product (GDP). The womenswear industry is the biggest, valued at $621 billion, followed by menswear which is valued at $402 billion.

Although the industry has been going through a tough period recently, the outlook is expected to be brighter according to McKinsey. And the changes in the outlook over the past years did not see any major changes as the price of cotton futures has been relatively stable.

In the past decade, the apparel industry is estimated to have grown at a pace of 5.5% annually. The retail clothing and apparel industry is no doubt one of the biggest and influential and depends on a number of factors.

In fact, McKinsey ranks the global apparel and clothing market as the seventh largest economy, if ranked according to GDP and alongside the individual countries.

The apparel and clothing industry is often influenced by changing trends in the fashion industry which in turn have an impact on the demand side of the business. Therefore, cotton is often seen competing with other fibers as well and this change in fashion trends can play a major role.

These changes can often be independent of the supply or even cost factors and therefore, it is important to keep track of the changing trends in the clothing and fashion industry.

What factors influence the price of cotton futures?

When it comes to the prices of the cotton futures, there are a number of factors that producers, merchants and speculators look to in ascertaining the right prices and from a trading perspective as well.

The most important is of course, the U.S. Department of Agriculture (USDA) forecasts. According to recent reports, the department’s data showed that the world cotton output has been in a steady decline, falling at the rate of 5.4% in harvest from major producers.

The U.S. output for cotton is also expected to fall by close to 2.1 million bales to 141 million bales. Meanwhile output from China, one of the major cotton producers is also expected to fall by 2.0 million bales.

Producers or cotton farmers also need to focus on crop disease which is an important element in determining the crop output which can eventually influence the global cotton futures prices. Crop disease is an important risk to agricultural commodities that can wreck havoc and can bring unseasonal shifts in the markets concerned.

Cotton prices are also impacted by the oil prices interestingly. Among all the agricultural commodities, cotton is said to have the highest per-acre energy costs and thus, higher oil prices tend to have an impact on cotton prices as it can increase the input costs which can result in higher prices.

Considering the above factors, cotton futures prices can be volatile from a number of reasons and one of the ideal markets that is therefore used by speculators for day trading

Besides crop disease, the weather also plays an important role in determining the output of cotton and the resulting prices, which can impact the supply side of the markets. Because rainfall is essential to the cotton plants, droughts or even floods can wreck havoc with the crop.

It is estimated that cotton plants require 24 – 48 inches of water annually and irrigation costs plays a major role in impacting the prices as a result as the higher prices can quickly add up significantly and build up into the initial price.

From a trader’s perspective, for day trading, cotton futures are one of the ideal markets to trade due to the volatility and of course the margin requirements.

The cotton futures contracts are available for trading on the CME exchange as well as the ICE futures exchange and the image below gives an overview of the futures contract specifications.

Between the two exchanges, the ICE futures exchange cotton contract are cheaper to trade compare to the CME futures exchange contracts. Traders should also bear in mind the different ticker or symbols for the cotton futures for both of these exchanges.

Impact of cotton prices in the global market

While cotton futures prices have an impact on the input costs for the manufacturers, the cotton prices tend to impact the end product in some aspect. Although due to the fact that clothing sales are often determined by fashion trends, the general state of the economy, prices and so on, the effect of cotton futures are limited.

In order to understand the impact cotton prices have on the global retail trade, it is important to know some of the factors that influence the trade. One of the biggest competing raw materials for the apparel industry to cotton is polyester.

Polyester is a cheaper alternative to cotton and the material has been in a state of oversupply which has helped many manufacturers to opt for Polyester. The fact that it is a cheaper alternative translates to lower prices for the end consumer making it more popular among manufacturers.

Thus, the raw material cotton is often seen competing with polyester. This also comes amid the fact that China, India and Pakistan, which are the top three global cotton producers, have been facing problems ranging from factors such as floods, drought and tighter restrictions on exports.

Besides being one of the globally top producers for cotton, the above countries are also regions of high demand for the clothing/apparel business and thus, China and India especially play a big role when it comes to determining the trends and prices of retail clothing.

The economy also plays a major role in determining the supply and demand factors for cotton. When the economy is weak, the consumer’s spending power is also relatively weaker tends to hit the bottom line sales of the apparel, this tends to have a chain reaction leading to lower than expected requirement for cotton as a raw material.

Government policies also play a role in shaping the price of cotton prices. This is due to the fact that governments across most of the cotton producing nations have put in place the various subsidies and measures in place in order to insulate cotton farmers from the price volatility.

It is widely documented that one of the central variables that determines the price of cotton is the policy directive from the Chinese government. One of the primary reasons used is for cotton prices trading below their cash value. The cotton producers in China have been known to stock on the raw material in an effort to make prices more competitive amid creating shortage in the markets.

The government subsidies can change from time to time and is also another factor that can influence prices of cotton that needs to be accounted for, both for traders who wish to speculate on the cotton futures prices as well as long term investors who want to invest in the retail clothing and apparel sectors.

iPath Pure Beta Cotton ETN (CTNN) and iPath Bloomberg Cotton Subindex Total Return SM ETN (BAL) are two of the top most cotton ETFs for stock investors for investors who wish to track the commodity from a retail perspective or for general investing purposes.

Among the retail clothing industry, companies such as Under Armour, American Eagle, Tommy Hilfiger, Coach, Michael Kors and Gap are some of the top companies in the world.

Industry trends in the clothing and apparel sector

The fashion and clothing industry is one that is dynamic and fast changing and depending on the trends, demand can be expected to rise and fall accordingly. It is estimated that in 2017, the retail fashion and clothing industry is expected to remain stable.

Sales are expected to grow around 6% – 8% for the year, mostly on account of global demand. But the pace of growth in the retail clothing sector is facing stiff competition from other retail sectors that include healthcare, rent, and electronics and so on.

Politics are also expected to play a big role in shaping the outlook for the retail clothing sector, especially as the current U.S. administration continues to pursue uncertain economic and trade policies.

Relationship between cotton futures and the global retail industry in apparels

Thus, in conclusion, the cotton futures prices tend to play a significant role in impacting the global apparel and clothing industry. However, considering the fact that clothing manufacturers are now open to more choices, cotton is facing stiff competition from polyester and other fibers which are cheaper.

Besides the pricing factor, the more recent reports from the United States Department of Agriculture (USDA) showed that the world ending stocks are projected to decline in the years 2017 – 2018. This is expected primarily on account of decline in stocks from China.

Therefore, the market is expected to tighten a bit more largely on the supply side than on the demand side of the scale. Besides China, the forecasts for growth in the use of cotton are moderate with an estimated 1% growth while non-Chinese production is expected to rise for another year.

Meanwhile, the U.S. cotton exports are expected to remain steady at the rate of 13.2 million bales for 2017 and 2018. While the supply side tends to affect the cotton prices which in turn impact the global retail industry, the trends and demand also pays a major role.

When fashion trends dictate that consumers prefer other fibers to cotton, manufacturers have to oblige, which tends to have a reverse effect on the cotton, as it reduced demand for the raw material.

Therefore, cotton and the retail apparel and clothing industry can see a tight relationship which can affect prices on either side of supply and demand.

When the price of coffee futures fell more than half from the peaks of $137 in August 2015, the benefits of lower coffee prices were passed on by most of the merchants.

Starbucks was however the exception, as the company back in 2015 was reported to have hiked the prices of coffee.

While Starbucks did not have much of competition initially, in the past few years, that has changed. Companies such as McDonalds, Dunkin Donuts have started to give Starbucks a run for its money. Keurig Green Mountain Inc (GMCR) is one of the other big names that has an exposure to coffee. Unlike Starbucks, Keurig Green Mountain Inc. is a specialty personal beverage system producing coffee, coffee makers, tea and other beverages in the U.S. and Canada.

Starbucks initially launched some 40 years ago in 1971, starting with just one store and has since then experienced phenomenal success, transforming something as simple as coffee. The company is attributed to have taken a commodity as simple as coffee and turned it into an experience.

Starbucks has become the go-to coffee place, be it for work or just to socialize. The marketing approach and the concept has led to the company’s revenues growing consistently year over year, with 2016 revenues estimated to have been at $21.32 billion.

Previously, coffee futures posted a strong rally as a buildup of various factors such as drought and rust in some of the major coffee producing regions led to fears of lower output. This in turn pushed prices of coffee futures higher.

Coffee rust, known as la Roya is a type of fungus that is no newcomer to the crop. The fungus played havoc in 1860, in Sri Lanka as it nearly destroyed all of the coffee and tea plantations in the region.

Thus, the weather and disease factors played a role in pushing the price of coffee futures higher. However, as conditions started to improve and coffee futures prices started to tick higher. But in terms of the benefits, as far as Starbucks was concerned, there has been little to show for.

Since coffee forms an essential element of the Starbucks business, the influence of coffee prices and the stock price of Starbucks is often a favorite pastime for many.

Starbucks is known to hike prices of its products at regular intervals. In July 2016, the company hiked the prices by $0.10 – $0.20 on select brewed coffee as well as tea products. The chart below shows the overlay of the Starbucks (SBUX) stock price chart on the IC Futures Coffee chart (KC).

While it does seem simple to draw up some conclusions comparing coffee futures prices and the stock price of Starbucks, the relationship between the two are not as simple as it looks to be.

Despite rising prices for coffee, a report from Bloomberg, late last year showed that U.S consumption of coffee continues to rise at record highs.

The U.S. per capital consumption of hot coffee was said to have risen to 3.1 kilograms in 2016, up from 3 kilograms in the year before. The total domestic coffee consumption is said to be up 1.5% over the 12 months starting October 1, 2017, data from the U.S. Department of Agriculture said.

What factors impact coffee futures prices?

The price of coffee futures has increased tremendously in recent years as the drink has grown to become popular both among consumers as well as an important cash crop.

When talking about coffee futures, Arabica and Robusta coffee beans are the most commonly traded version of coffee beans on the exchanges. Among the two, the Robusta coffee beans are the more expensive versions than the Arabica coffee.

This is mainly due to the fact that big companies such a Kraft, Nestle, P&G prefer purchasing Robusta coffee than Arabica. On the contrary, Starbucks uses Arabica coffee beans

Between Robusta and Arabica, it is widely accepted that Arabica beans are better tasting than Robusta as they are mild and aromatic. Robusta on the other hand is said to be harsher and are said to have more caffeine than Arabica.

Among the different factors that influence the prices of coffee, geo-political factors ranks quite high. This is due to the fact that coffee production is often concentrated in regions where political stability is often not one of the strong points.

For example, as of 2016, the top five coffee producing nations in the world were; Brazil, Vietnam, Colombia, Indonesia and Ethiopia. Most of these countries often witness political turmoil and these factors tend to add to the uncertainty when it comes to the crop’s exports.

Furthermore, the regional disturbances can have an influence on the export prices as well which could eventually translate to higher coffee prices in the international markets.

Climate is another big factor that can influence the price of coffee. The crop is highly sensitive to the weather conditions. Rain is one of the most important climatic factors that influence the coffee production. More importantly, having the amount of rainfall at the right time is also crucial to the coffee production.

Very often, climate plays a major role and many a times is directly responsible for sending the price of coffee futures higher, especially as speculators start to push prices higher on negative news related to plantation.

Global warming is another major role that has resulted in unfavorable weather conditions. Brazil, which is the world’s largest coffee producer, has been hit by changing weather patterns. In 2014, prices of coffee futures rose sharply on an unprecedented drought. Rainfall is essential in the early months of crop plantation and is often used by market participants to gauge the estimates of production.

Enterprise demand and speculator activity are two factors that affect the price of coffee futures on the demand side of the scale. Because coffee futures are highly traded, they offer deep liquidity making it a prime futures contract that attracts speculator activity.

Speculators are traders who are not concerned about production or delivery aspect of trading but purely focus on profiting from the volatility in prices. Besides speculative trading activity, enterprise demand also influences the price of coffee futures.

Companies such as Kraft, P&G, Sara lee, Nestle are said to be some of the biggest consumers of coffee at an enterprise level. Thus prices tend to be more volatile and push higher on increased demand from these companies. Interestingly, Starbucks doesn’t fall into the category of “the big four” coffee roasting companies.

However, the big four often focus on purchasing Robusta coffee beans, but demand for Arabica also remains strong.

The Coffee Futures Contracts

In the world of futures, coffee is primarily traded on the ICE Futures Exchange. The coffee version being used on the ICE futures exchange is the Arabica futures with the ticker symbol C or KC.

The coffee futures prices trade in contract size of 37,500 pounds and the futures are priced in cents and hundredths of a cent up to decimal places. The minimum price movement of the ICE futures contracts at 5/100 cent/lb with the tick value of $18.75 per contract.

The ICE futures contracts are listed for March, May, July, September and December contract months.

The CME group also offers its own version of coffee futures with the ticker KT. The CME group’s coffee futures are also standardized in contract sizes of 37,500 pounds per contract which is priced in U.S. dollars and cents and has the same contract listed months as that of ICE futures.

The CME group’s coffee contracts have a minimum price fluctuation of $0.0005 per pound with the tick value priced at $18.75 per contract (similar to the contracts from the ICE Futures).

Between the two, the coffee futures (KC) from ICE futures are the most widely quoted and used as a benchmark when it comes to the Arabica coffee prices.

Does coffee futures price impact the stock price of Starbucks?

To a certain extent, the price of coffee futures plays an important role in determining the bottom line prices in Starbucks. Because Arabica coffee is one of the main inputs into the business, there is a certain amount of impact that coffee prices have on the revenues from Starbucks’ businesses.

It is estimated that coffee prices form as much as 20% of the company’s cost of sales or input costs, which was revealed by the company CEO, Howard Schultz in 2014.

Being one of the largest coffee chains, Starbucks has had an impressive run. In a three year period, Starbucks has consistently outperformed the S&P500 returns, while at the same time, the ICE futures Coffee has been posting a steady decline.

The above chart shows that there is a mild inverse correlation between coffee prices and the stock price of Starbucks. Thus, when prices of coffee futures (Arabica) fall, you can expect to see a modest increase or an improvement in the share price for Starbucks.

Traditionally, the common knowledge dictates that when the prices of coffee futures rise, it translates to higher costs of doing business for a company such as Starbucks. This means that the stock price of Starbucks is expected to fall.

While this inverse relation exists, it is a lot more accentuated on a daily time frame chart which shows the strong inverse correlation between the stock price of Starbucks and the price of Arabica coffee futures.

Thus, when coffee prices are trading lower, the stock price of Starbucks tends to appreciate. Similarly, when there are higher coffee prices, the revenues in Starbucks also take a hit.

But the question here is in regards to how the relative rise and fall in the shares of Starbucks. Because the company does not base its pricing on current or prevailing price of coffee that it purchases, the stock price can weather any short term impacts from higher coffee prices.

In fact, between the periods of 2013 – 2014, coffee futures prices appreciated by over 100%, as the price of Arabica coffee futures rallied from the lows of $100, to rise to a peak of above $200.00 by late 2014.

Within this same period however, the stock price of Starbucks fell only 12%. Furthermore, the correlation isn’t exactly symmetric as one can see that during the rally in coffee prices between 2009 through 2011, where coffee prices rose from around $104 to reach the highs of $290, the stock price for Starbucks was also growing steadily showing no signs of declines.

Thus, it is safe to assume that while coffee prices form nearly 20% of the input costs for the business, it is still too low to have any major impact for the business. Past price history shows that the stock price for Starbucks has managed to weather both the upturns and the downturns in coffee prices.

When price of coffee futures rises, the input costs for the company also increase, thus putting pressure on the eventual revenues.

One of the ways to gauge what impact coffee prices have on Starbucks is to read the quarterly earnings report, where the company gives out details on its coffee hedging strategy. For example, in the earnings report, the company said that it had over 50% of price locked for the fiscal year of 2017.

The comments signal that the company was purchasing coffee at a slower pace than before despite falling coffee prices as the company is known to take a very cautious approach when it comes to sourcing the highest quality coffee beans while also keeping an eye on fair economics.

While there is some form of inverse correlation between coffee futures and the stock price of Starbucks, the strength of the correlation is not too strong to base any investment decisions from it. What we do know is that when coffee prices exhibit strong rallies, the pace of gains in the price of Starbucks stocks tend to rise at a slower pace.

Exchange traded funds or ETFs remain at the forefront of investing community as the products continue to make inroads into all types of portfolios and trading styles and sizes. Thus, investors at different levels have often embraced ETF products due to the transparency, the cost efficiency benefits and the product structure.

As ETFs continues to evolve, the products have become more diverse with investors taking advantage of being able to tap into the difficult to reach asset classes. For example, investors can purchase ETFs that have exposure to the futures markets. By purchasing such ETF’s investors are able to indirectly gain access to the futures markets.

ETFs have become particularly interesting when it comes to the commodity markets. The wide choice of ETF products means that investors have the option to pick and choose the type of ETF products they want to trade or invest.

In the world of commodities, this translates to investors choosing from ETFs that have exposure to futures or to the mining and exploration companies to suppliers or distribution companies and so on.

Within the commodity markets, investors have often turned to copper across all market classes; futures, ETF’s, copper mining companies and so on. The metal continues to hold a great appeal among the investing community due to its widespread usage in just about everything.

Copper is an essential element used in the manufacture of household plumbing pipes to electricity conducting instruments and high-tech machinery as well. Copper is also said to be closely related to the economic cycles.

As housing and infrastructure continues to expand especially in the emerging markets, copper as a commodity for investment purposes offers investors compelling reasons to trade or invest in it. It is estimated that the appetite for raw materials, such as copper will continue to grow over the coming years, adding to its appeal.

How to invest in Copper ETFs?

Copper is part of the base metal that is well known since ages. It has become an important metal in the progress of a community. Copper is one of the few metals that has some properties that are similar to precious metals.

Gold and silver’s properties are somewhat similar to that of copper as it is ductile, malleable and is a known conductor of heat and electricity.

Despite sharing some similarities with its more expensive metals, copper is still relatively cheaply priced due to its widespread uses in the industrial and manufacturing sector. Copper is widely used in wiring systems, especially in households as well as commonly found in electronic circuit boards, plumbing and so on.

As a transmitter of heat as well as cold, copper is used in power generation as well and can be seen playing a critical role in supporting the telecommunications sector. Because of the various sectors dependence on copper, the metal is also said to be a good bell-weather of the global economy.

In fact, copper is often called as the metal with a PhD, and is commonly referred to as Dr. Copper, for its ability to predict the economic cycles.

Given the above factors, it is not surprising that copper takes space among investors as part of their portfolio. Investors these days have a wide number of choices if they wish to seek exposure to the base metal.

While investing in copper ETFs are just one aspect of investing, there are also copper bars and physically backed ETFs that can be traded, not to forget futures and options as well which are part of the derivatives asset classes that are available for trading.

No matter what type of asset class an investor makes use of, the most important thing to consider is the liquidity of the asset class which is important.

Within the exchange traded funds, there are many different types of copper based ETF’s. For example, investors can choose a copper ETF that tracks the futures prices of copper and rolls over the contracts to the front month.

There are also physical copper backed ETFs that offer traders a more direct exposure to the metal and finally there are copper ETFs that focus on the companies such as copper mining, exploration and distribution based companies.

Such type of ETFs often gives an indirect exposure to the investors who want to trade the base metal.

Among the basket of commodity ETF’s, traders can also indirectly opt for a mixed basket of commodities in order to diversify their risks. With such ETFs, investors will have a lower exposure to copper but they are able to diversify their risks

Thus, copper ETFs can be either pure-play such as the iPath Bloomberg Copper Subindex Total Return ETN (JJC) or the United States Copper Index Fund (CEPR) which tracks the copper futures contracts and a more diversified holding such as PowerShares DB Base Metals Fund (DBB) which has a mix of different copper products including U.S. Treasury Bills, Zinc and Aluminum.

Thus, when it comes to trading or investing in copper ETFs there are a lot of choices for the investor and no doubt many different variations of the products. Thus, copper investors should thoroughly investigate into the respective copper ETFs before they invest as different ETFs can yield different results.

What are the factors to consider when purchasing copper ETFs?

With ETF investing, traders and investors have the choice to choose between an exchange traded note (ETN) or an exchange traded fund (ETF). The difference between an ETN and an ETF is that the ETFs are classified as senior debt notes that are issued by institutional banks. Thus unlike an ETF, the ETNs are not subject to any counter-party risk. With an ETN, it is the institutional bank that promises to pay the returns of the index after excluding any tracking and management fees. Example of copper ETNs are:

• iPath Pure Beta Copper ETN (CUPM)
• iPath Bloomberg Copper Subindex Total Return ETN (JJC)

For ETFs besides the obvious parameters such as the expense ratio and the assets under management, investors should also focus on a number of other important factors when it comes to investing in an copper ETF. These are:

ETF Product Structure

The product structure of the exchange traded product is an important factor to consider. Investor should know that not all ETPs are created similarly and this factor is often overlooked. In fact the structure of the ETP is what eventually determines the returns.

With copper exchange traded funds, investors will often be faced with a choice of choosing between an ETP that focuses on the futures front month contracts, commodity pools and exchange traded notes. As mentioned earlier, investors need to pay attention to ETNs as they come with a counter-party and credit risk.

On the other hand, copper ETFs such as the United States Copper Index Fund (CPER) is a structured commodity pool. The differences mean that investors also need to focus on the tax implications based on the way the ETF is structured.

Holdings: Futures vs. Stock

Copper investors must also figure out how they wish to select the ETFs based on the exposure to the underlying asset. Some investors prefer to focus on ETFs that track the futures prices of copper, while an indirect approach could be to look at ETFs via copper miners.

With a futures based holding in an ETF, the fund is more active as they need to sell the copper contracts which they hold as the contracts near the expiration date and in turn have to purchase the new front month contracts.

This process is referred to as the rolling over of contracts and it can affect the overall returns of the ETFs that track the futures prices. For example, when the futures markets are in contango, the longer dated futures prices are trading a premium compared to the nearest month contracts prices which are approaching expiration date.

Thus, there are times when the futures prices tend to deviate away from the spot prices and can also be volatile on a day to day basis.

On the other hand, opting for a commodity producer such as miners brings with it, a new set of issues that investors should deal with as well. For example many copper miners tend to hedge their exposure to the underlying asset, via selling the goods in the future and locking in a price.

Therefore such swings in the spot market prices of copper don’t necessarily mean that the copper producers will be selling at exactly the same price.

The stocks of the copper miners are impacted by the spot prices of copper to a certain extent only but there is no perfect correlation between the prices of the metal itself. Still, in terms of volatility, copper producers prices offer a lot more stability than compared to the futures based ETFs.

Secondly, investors who prefer a buy and hold approach will find that investing in a copper ETF with holdings of copper producers and/or mining companies can offer greater benefits such as utilizing stocks that have tangible assets and cash flows compared to copper futures which are mostly speculative instruments.

The Rollover in futures prices

Copper investors who prefer to invest in futures contracts based ETNs will have to pay particular attention to the rollover in the futures contracts. This might seem not so significant, but the rollover decision can play an important role in determining the exposure to the contracts, both expiring and the front month.

The iPath Bloomberg Copper Subindex Total Return ETN (JCC) is one such example as the ETN rolls out the exposure to the future month contracts. It can be a great tool for short term trading, but not ideally suited for investors who prefer a buy-and-hold approach.

Market factors such as contango in the futures markets could significantly eat into the returns from the JCC.

What Copper ETFs should you invest?

As outlined above, investors have the choice to choose the type of copper ETF they want to invest in. For those who are short term or do not mind the volatility, investing in a futures contracts based ETN can offer decent returns in the short term, while investors who like a buy and hold approach prefer to make use of a more diversified commodity pool or an ETF that is made up of copper producers or miners.

Here are three copper ETFs that are worth considering for investors who prefer to invest in copper ETFs.

iPath Bloomberg Copper Subindex Total Return ETN (JJC)

The iPath Bloomberg Copper Subindex Total Return ETN (JJC) is known as one of the oldest copper exchange-traded product on the markets. The JJC ETN also boasts of one of the largest number of assets under management in the copper market.

The iPath Bloomberg Copper Subindex Total Return ETN has an expense ratio of 0.75% and the fund has an inception date since October 23, 2007. The JJC ETN boasts of total assets under management (AUM) of $73.7 million.

What’s unique about the JJC ETN is that the product rolls out the exposure to the front month copper futures contracts and thus, traders holding JJC ETN shares are exposed to the potential credit risk from the issuing institution.

iPath Pure Beta Copper ETN (CUPM)

iPath Pure Beta Copper ETN (CUPM) is an ETN that maintains the flexibility to roll exposure into a number of different contract months and although this looks similar to the iPath Bloomberg Copper Subindex Total Return ETN (JJC) it is structured slightly differently.

The CUPM ETN uses a Pure Beta methodology where in the decision on the rollovers are based on the observed price signals as well as the slope of the copper futures curve. The CUPM has total assets under management worth $0.7 million and this is one of the lowest among the three copper ETFs mentioned here.

The CUPM ETN has an expense ratio of 0.75%.

United States Copper Index Fund (CPER)

The United States Copper Index Fund (CPER) has total assets under management to the tune of $14.6 million and has an expense ratio of 0.65%. The CPER is a commodity pool and seeks exposure based on a basket of ETF contracts.

The CPER ETF makes use of a unique roll methodology so as to address the shortcoming of the JCC ETN by maximizing backwardation and minimizing the effects of contango.

Besides the above three copper ETFs there are many more choices that are available for investors. With due diligence and focusing on the way the copper ETPs are structured, investors can take a more personalized approach into investing in the right copper ETP of their choice.

The theory of economics offers many explanations on the existence of the organized futures markets which have been often questioned by traders. Early on, the initial school of thought postulated that the reason for existence of the futures markets was due to the ability to offer price insurance.

This line of reasoning gave the view that the futures contracts were tools that businesses could use to manage their risks on the exposure to the main assets via the futures markets.

Thus, futures markets existed due to the fact that it offered speculators and investors, the prospects of offering positive returns. However, the fact that price risk can be transferred using the forward contract gave the view that neither of these two points were valid.

Another opposing view for the reason why the futures markets existed was because they offered speculators lower costs of transactions for the same assets if they dealt with the cash markets. The futures contracts are traded in an organized framework and come with an elaborate set of rules for trading.

The above characteristics are seen as a way for minimizing the transaction costs and to make the futures contracts superior to trading other derivatives such as the forward contracts.

What is the role of the futures markets?

If one looks at the futures markets as the derivatives markets, the answer is a resounding yes. Futures markets are required for traders because offers the benefits of:

• Price discovery
• Risk management
• Speculative activity

All these three aspects are essential for the economy to function properly.

Price discovery

The derivatives markets play a crucial role in determining the price discovery for the current and the future prices of the commodity or the asset. Price discovery is one of the most essential aspects of the economic system as prices of the assets move in the same direction in the expectations of the market participations.

Price discovery is important and especially critical for the producers and the merchants. For example, if a silver mining company wants to sell their silver in the market a month down the line, the best way for price discovery is the futures markets where based on the supply-demand, the silver mining company can therefore know the price of the futures contract.

Likewise, from a merchants’ perspective the futures markets can allow the merchants to validate the price of the futures contracts for the silver assets that are common and could therefore enable merchants from anywhere to validate their prices and trade accordingly based on the futures pricing for silver.

Risk Management

Market uncertainties can often expose the market participants to unexpected losses in many different ways. The derivates markets in this aspect can offer the market participants the opportunity to hedge their risks by trading the derivates such as the silver futures in this case.

For example if a trader has purchased some contracts in the spot market for silver and they expect the price of silver to fall in the near future but unsure how big the decline will be, silver traders can simply look to going short on the silver futures contracts and hedge their risks accordingly.

Besides the above example, even stock traders can look to the silver futures markets where they can hedge the risks of price volatility in silver directly and manage their exposure to the silver mining companies accordingly.

Thus, silver futures play an important role in providing risk management for the market participants which would have been otherwise impossible.

Speculative activity

Speculators in the futures markets make up for a significant portion in terms of bringing volatility and liquidity to the markets which would have been otherwise dominated by simply the merchants and the producers.

Due to the volume of activity, speculators can quickly switch positions from long to short or vice versa. More importantly, any price imbalances are quickly filled by the speculators who are constantly on the lookout for any arbitrage opportunities that presents itself every now and then.

One of the main factors driving speculative trading activity in the futures markets is not the fundamentals but the mass sentiment in the markets. Speculators often tend to be irrational and at times can switch positions quickly which may seem counter trend or counter intuitive. What they do as a result is ensure that there is deep liquidity in the futures markets, which is essential.

The price imbalances along with the speculator activity ensures that the futures markets pricing is always in a state of constant price discovery and reflects the true market value at any time.

Unlike the merchants and the producers who deal with the underlying asset in one form or another, such as farmers growing crops or the merchants taking delivery of the raw materials or the underlying asset speculators are a lot more flexible.

Because speculators do not deal with delivery of the underlying contracts, such groups of traders are flexible and quick enough to take advantage of the volatility, in part contributing to the volatility themselves.

One of the key aspects that helps in understanding the silver futures markets is the fact that the futures markets brings about flexibility in the way traders can deal with the asset in question.

Characteristics of the silver futures markets

We can identify that the silver futures markets, just like any other asset or commodity that is traded on the futures markets needs to have some characteristics to make it successful. Some of these include:

• Uncertainty
• Price correlations
• Potential for interested participants
• Value of transactions

Uncertainty

This is one of the key reasons for the futures markets to exist in the first place. When market participants are unsure about price, then the buyers and sellers with exposures can make use of the futures markets to hedge their risks. Without uncertainty, there would be no requirement for traders to make use of the futures markets to hedge their risks.

Price correlations

Price correlations in the futures markets refer to the prices across the different specifications and the locations of delivery of the assets in question. Typically, a futures contract is based on the commodity or the asset which is standardized in the grade and the location of delivery.

Futures markets, based on the contracts can help in establishing the grades and the price differentials which broadens the appeal for the futures markets. The correlation can also help speculators. For example, gold/silver ratio is a metric that is commonly used in the markets.

The gold/silver ratio tells how much of silver can buy one ounce of gold and thus shows whether gold is overpriced or underpriced compared to silver futures. Traders can make use of this correlation between the gold and silver futures prices to understand when to buy or sell silver.

Potential for interested participants

When there are a large number of market participants involved in the asset’s production, delivery and consumption, the larger the potential for attracting a wider range of market participants.

In the silver futures markets, the mining and exploration companies make up the producer side of the business, while electrical component manufacturers, jewelers and other businesses having to do with silver make up the consumption side of the business.

Between the producers and the merchants, the speculators make up for the remainder of the market participants who are responsible for bring liquidity and volatility to the silver futures markets

Value of transactions

With all things being constant, greater the value of the product that is sold, the bigger the value of reducing risks. In other words, when there is more at stake, investors who are averse to risk often want to hedge more in the derivatives markets. Similarly, traders also want to speculate more in such markets as well.

This is because there are bigger incentives for people to invest and speculate when the transaction values are large.

The downside of the silver futures markets

Despite the fact that the silver futures market brings long term benefits in maintaining the market equilibrium, it is by no means fool-proof.

Although the futures markets have become more vigilant and tighter in terms of compliance, the most famous story of the silver futures markets is the story of the Hunt Brothers who attempted to corner the silver market in the early 1970’s via futures.

The Hunt Brothers, William Herbert and Lamar started to build big positions in the silver futures over the years. By 1979 the Hunt brothers as they were commonly referred to managed to build an estimated $2 billion to $4 billion in positions, speculating on silver.

The silver holdings based on their contracts were estimated to be around 100 million troy ounces. During the process of accumulating the silver futures for nearly nine years, the Hunt brothers managed to push the price of silver from $11 in September 1979 to $50 an ounce by January 1980.

Silver Thursday, which occurred on March 27, 1980, saw the prices of silver fall sharply leading to a panic in the markets. Around the time, the Hunt brothers were estimated to have held nearly one third of the world’s silver supply (at least on paper).

The strong rally in the silver prices eventually led to the COMEX exchange changing rules on leverage and margin, which left the Hunt brothers who were already heavily leveraged vulnerable to the additional margin requirements.

As the silver price started to fall sharply, the Hunt brothers were in effect faced with a margin call from their brokerage firms to the tune of nearly $100 million. Unable to meet the margin call requirements, the hunt brothers were faced with a potential $1.7 billion loss on their trades.

As a consequence of the attempt to corner the silver market, a consortium of U.S. banks had to eventually come together to form a rescue package for the brokers with whom the Hunt brothers had become over-leveraged.

The silver market manipulation is often widely quoted by many opponents to the futures markets who often cite that the futures markets are manipulated. One of the biggest gripes being that the futures markets for silver has become a hotbed for speculative trading with no underlying assets to back up the contracts.

This is further evidenced by the fact that the silver futures markets is no stranger to sudden price drops that are a common occurrence in the precious metals futures markets, including gold and silver.

This is however attributed to the algos and automated trading with no concrete evidence ever presented so far that points to manipulation in the precious metals futures markets.

Although the term silver futures might limit it to the asset (silver) the fact that this remains the key commodity for most of the other assets makes it important. For example, silver mining stocks are merely a reflection on the trader’s valuation on the silver mining business.

Thus, although trading silver mining stocks is not directly related to silver, it is indirectly related and as a result, the price movements in the silver as an asset tends to have an impact on the stock price of the silver mining stocks.

Although one could argue that the spot markets are efficient in itself, the silver futures markets brings an additional layer of price discovery and equilibrium. Furthermore, the basic framework of the futures markets enables traders to transact in the contracts efficiently.

While silver futures prices tend to track the prices of the spot silver futures markets, the fact remains that the spot futures markets are largely unregulated and can be subject to price manipulation. Thus, the silver futures markets are the next best option for traders who prefer a more transparent approach to trading.

Because of the way the futures markets are designed, traders who are directly dealing with the silver futures contracts can also focus on the aspects of transparency such as the settlement prices, the trading volume and so on, which is clearly missing in the spot markets for silver.