Background History


The two schools of traditional market analysis.

In traditional market analysis there is a persistent problem in linking circumstances in the market to price. There are two main, rival non-mathematical approaches to the price cycle, each of which has one strength and one weakness. Mathematical modelling brings the two approaches together in a quantitative way, and also allows the cash price, the three-months (3M) price and the cash-3M spread (the contango or backwardation) rigorously to be dealt with.

Metal Price dependency on Stock Levels and Stock Change.

The dominant non-modelling approach focuses on cycles of surplus and deficit which in turn drive cycles of stock change. Specific stock levels (or stock to consumption ratios) are then assumed to correspond to specific price levels. For some LME metals the stock to price relationship is poor, while for others it can be moderately good. The particular problem with this approach is that it is very poor at indicating peaks and troughs.

Metal Price dependency on Global Industrial Production Cycles.

While the first approach is followed by many single-metal specialists, there is a second approach which tends to be favoured by multi-commodity analysts, who observe that the shift from bull to bear markets tends to coincide with the peak to global industrial production (IP) growth and the transition from bear to bull markets coincides with the trough to the IP growth cycle. This approach gives less guidance on price levels however.

The Global Industrial Production Cycles influence on Stock cycles of Surplus and Deficit.

A change in demand growth rates (IP growth serves as a good proxy) immediately triggers the primary price response, which only after a time lag triggers a supply response, and that lag initiates cycles of surpluses and deficits, which lead to secondary – or fine tuning – price adjustments.

The effect of the US dollar strength on the metal price.

As well as the importance of the Metal Stock and Global Industrial Production drivers, the strength of the US dollar must also be considered. As the US dollar strengthens, metal prices in dollars fall and as the US dollar weakens, metal price in dollars rise.

The influence of Pension Fund money from mid 2005 to 2012.

Relatively simple price relationships of this sort were stable for a long period, from before 1990 to the middle of 2005, but then started to become unstable when pension fund money suddenly began flowing into the relatively small base metals markets in the tens of billions of dollars, and cash and forward prices of all of the LME metals began to turn upwards from modelled levels.

The stabilisation of fundamental driver relationships around 2012- 2015 allowing factor models to be used once again in determining the metal price.

After the flood of pension money abated, the price relationships of the LME metals began to stabilize again (mostly from 2012, but a little later, from 2015, for tin stocks and prices) and mathematical modelling again became able to assist with analysis and forecasting of cash and 3M prices and the cash-3M spread.