Five Minutes with Marc Dulin
Marc Dulin, president and managing director of MetalPrices.com, has participated in the metals markets for more than 30 years. He spoke with JLN editor-in-chief Jim Kharouf about how metals prices are created for OTC markets as well as macro developments that are changing the way in which financial, physical and retail investors are using the metals markets.
A: Price discovery is fairly different for each metal group. Metals on exchanges are pretty liquid and fairly transparent. Metals traded over-the-counter are less liquid and have less transparency. Their markets are typically much smaller, but the advantage we have with the minor metals and non-ferrous metals is that our market specialists have 25 to 45 years of experience buying and selling metal products. A few have worked in casting shops and that adds much more value to what they do. They understand both the nuances of the market and their supply chains.
Regardless, price discovery has its problems whether its traded on an exchange or OTC. The challenge with reporting these prices is to be reliable, consistent and authoritative. LME, COMEX and others are highly liquid markets, regulated by governing bodies. Gathering market information on OTC products, begs the question over price reliability and price integrity. And in addition, there is no governing body.
One approach for OTC products is gathering transactional data and calculating the values based on these volumes. Even though this approach has its merits, there are big issues, if the transactional data is sufficient, to accurately reflect market conditions. If there is less liquidity, there is higher probability of inaccuracies. If volume increases and decreases, it invites innovative calculations to smooth out anomalies in the market.
Our methodology focuses on surveying key market participants, both buyers and sellers. And essentially, this approach is very subjective. When we collect information, we evaluate it based on market conditions and objectively report it. And with our experience, we tend to report consistent and accurate price assessments. Despite this downside of using a subjective/objective approach, which many people object to, it’s really a test of time as to whether our prices are truly accurate. We do invite people to challenge us if our prices are inaccurate, because it allows us to reevaluate our reporting. Over the years, there have been very few instances where we had to make adjustments.
Q: What is the size of the metals market?
A: It’s massive and its global. What you see now is more mining companies moving to Africa. The Chinese have a lot of interests there. And its pretty ubiquitous, whether you’re in Mexico, South America, or the United States. What I find interesting is that there is a lot of uncertainty in the global economy and that has a tremendous impact on the trading community and physical business. We all know that China is the biggest consumer of commodities. They are starting to reevaluate their economy, based more on consumption versus making consumer products.
There are just a lot of anomalies in the market right now. The metals industry has grown exponentially in the last 20 years and it’s all because of China.
Q: So why is that important to traders, end users and so on?
A: Most companies do not want to provide transparency in the marketplace because it erodes profit margins. So when you survey market participants, the challenge is to get them to talk to you. And many people do not want to talk to the media. The more information that is out there, the more you educate people and the less ability you have to make a lot of money. I take a contrary view that if you use certain financial tools, there is always an upside and downside to mitigate that risk and manage that business more effectively. Having price reporters like we do and understanding the nuances, we will be able to make an assessment as to whether an individual is trying to push the market in one direction or another. Naturally, when we talk to people, they will not always tell us the truth. So its their ability to understand the market from a broader perspective. If you don’t understand those complexities and nuances, its very difficult to report accurate pricing.
Markets are so volatile today and there is so much that affects the price discovery process. If you don’t understand the prices and report inaccurate prices over a period of time, that creates uncertainty itself.
Q: As you look at the metals industry - how has the metals market evolved or changed from the standpoint of new products/contracts on the market, as well as the pricing of those products?
A: It’s highly competitive and highly volatile. There are more players. Margins have decreased, and because of that, players have to do more due diligence to mitigate risk. And so there are a lot of financial products being created, such as indexes. These are created to bring more transparency to the marketplace and enable people to manage their price discovery more effectively.
We recently launched a North American scrap price index for the steel industry. The two gentlemen who report that are Mike Marley and Bryan Berry, two metal veterans who have been reporting metal prices since the 1970s and 1980s. We cover major regional cities in North America. But the problem with some of the indices is that, for the scrap steel industry, they are very slow to embrace risk management. They’d rather be in Las Vegas gambling. But because the global marketplace is being thrust upon them, they will have no choice but to use indexes or hedge to mitigate their risk. And you have a new generation of people coming out of college with advanced degrees who are a little more sophisticated in how they run businesses. A lot of old companies have used the same method or approach for many, many decades. They are huge institutions that are slow to change. But if it doesn’t come from within North America, it will come from the outside.
Q: Exchanges have been trying for years to launch or grow a steel futures contract, which speaks to your point. They have not been successful.
A: Volumes have been pretty poor. CME is trying really hard to promote it. But you can’t do everything transactional based. For example, if contracts have one particular grade and there is not enough volume in that, then they use different grades. That’s sort of strange because these different grades have different market dynamics that do not correlate with the initial grade.
You can use all the algorithms to smooth out prices but at the end of the day, can you rely on that?
The question is, can you take data from anywhere and make an index and trade off it? If you are financial institution, then yes. But will the physical business embrace it? And if the CME is successful in promoting its new product with the financial community, but the physical community does not embrace it, then it’s worthless.
Q: Do you see a lot of correlations between exchange traded contracts and OTC metals?
A: We report over 570 prices. But remember, when companies create products, they are usually alloyed, such as a copper-based item in your iPhone as well as a gallium product in there. So if you are a major manufacturer, and copper is going crazy and gallium isn’t, that is important to you. For the financial community, probably not. But for someone in the physical business, they look at these trends.
Some companies take this historical data and create indexes internally to determine what an overall commodity pricing index might be. This is such a dynamic industry and the question is, how do companies use data? With the financial industry, banks are investing heavily in the warehousing part because there is tons of money in it.
So there appears to be a dichotomy in the use of metals markets. One is for the investment community and those who are in the physical business. Personally, I believe there is a conflict of interest. I don’t particularly think its healthy in the long term for the global economy. If you are strictly financial, that’s great. But we’re overloaded with too many financial products out there and we’re not producing any more brick-and-mortar type businesses.
Q: As you look at the broader spectrum of users of metals markets, what does the landscape look like? Is there much more room for growth? If so, from where?
A: It all depends on China and if they can switch to a more service-based or consumer-based economy. This is going to have a negative effect on commodity traders as well as physical traders, because there will be less demand. But at the same time, for the investment community and with ETFs and ETNs, there is potential for that business to grow. And part of that is what is happening with sovereign debt. I think the insurance sector will absolutely grow into this space because more products will be created for both retail investors and the physical business. When you think about the physical side of the business, there will be more R&D invested. Will aluminum replace steel as the major component in automobiles? Possibly. I think there is a great future for metals, but it won’t reflect what has happened in the last 15 to 20 years, when a large amount of metal was produced to meet China’s appetite for growth. There is a lot of infrastructural growth that will take place throughout the world, in Africa, the Middle East, India. I think as the world becomes more competitive, we’ll see more metals come into play.
Q: You are seeing more diversity in metals then?
A: More diversity and more sophistication in how they are used. And with that, you’ll see a lot different products coming from the insurance sector and financial community as well. The number of people will decrease to a certain extent.
I went to the LME dinner two years ago, and the number of people there was astounding. A lot of these people have jobs because of China. But China has cut back and you’ve seen the implosion of the capital markets where firms are closing up.
Q: And the steel industry continues to change.
A: We have a report called Marley’s Heavy Melt. It lays the groundwork as to why the scrap steel players need to be more sophisticated, as well as steel mills, on how they mitigate risk. Frankly, if I had to trade scrap steel, I’d have ulcers right now. When I traded copper-based alloys, I was able to hedge 95 percent of my inventory. I could sleep at night. What’s happening in the steel industry is the steel mills can cancel orders at any time, suppliers don’t know what to buy at what price because they have no idea what the market is going to settle at. Typically, the market settles at the beginning of each month. But as the month progresses, there is so much uncertainty about what the next month will bring, or if at the end, steel mills will cancel orders that have not been received. So there is so much uncertainty and volatility in pricing today that I think that the old way steel firms have done business will eventually implode. And they will be forced to use certain indexes or derivatives and be more transparent in how they do business.
Q: What’s next for MetalPrices.com?
A: We’re going to add more global price assessments for the OTC products. We’re going to add more editorial content, and more functionality to our site. I do believe that metal prices is a niche market. The differentiating factor is that we have metals veterans that work for us and understand the markets. And we’re quite affordable. I see the Bloombergs and Reuters as the space shuttle and we’re more like the Lexus or BMW - we’ll get you there.