Hedging Against Rising Nickel Prices using Nickel Futures

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Using ETFs To Hedge Against Rising Rates

September 29, 2020

The September Federal Reserve meeting passed without much fanfare, quieting markets that had been getting jittery about a rate hike. The central bank―eyeing the uncertainty of a presidential election in November―chose to delay its much-anticipated interest rate increase, but not for long.

After the no-change decision, Federal Reserve Board Chair Janet Yellen told the press that she expects a rate hike sometime this year. That means that an increase may come either at the November or December meeting, with most economists targeting the latter as the likeliest option for a move.

If so, it will be deja vu, for it was last December when the Fed hiked rates for the first time in nearly a decade after months of anticipation. Another hike this December would push the federal funds rate up by 25 basis points to a range of 0.50-0.75% from 0.25-0.50%.

Rates Down From Start Of Year

Market-set rates are up from their lows ahead of the potential rate increase, though they’re down significantly from where they were at the start of the year.

The two-year Treasury bond yield, for example, is at 0.75%, up from a low of 0.50% in June, but down from 1.05% on Dec. 31. At the same time, the 10-year Treasury bond yield is at 1.56%, up from a record-low 1.32% in July, but down from 2.27% on Dec. 31.

It’s impossible to say whether the next Fed hike will be the catalyst that finally spurs a big rally in interest rates (and sell-off in bonds). But for investors who want to protect themselves, there are many tools available in the ETF world to minimize the impact of higher rates, or even capitalize on them.

Lower Duration Bonds

The classic advice given to investors in a rising rate environment is to reduce the duration of your bond portfolio. Duration is a measure of interest rate risk and is based on a bond’s maturity and coupon payments.

A higher-duration portfolio has more interest rate risk than a lower-duration portfolio. By reducing duration―for example, by buying shorter-term bonds―a portfolio will have less interest rate risk. The flip side is that the portfolio will probably have a smaller yield as well.

There are plenty of low-duration ETFs on the market that can help reduce the average duration of an investor’s portfolio, including the iShares 1-3 Year Treasury Bond ETF (SHY), the PIMCO Enhanced Short Maturity Active ETF (MINT) and many more.

Inverse Bond ETFs

Another method with which to hedge against rising rates is inverse ETFs. These funds short Treasury bonds, meaning they rise in price when interest rates increase (bond prices and rates generally move inversely).

The ProShares Short 20+ Year Treasury ETF (TBF) provides daily inverse exposure to Treasurys with maturities greater than 20 years.

Meanwhile, the Sit Rising Rate ETF (RISE) shorts futures contracts on two-, five- and 10-year Treasurys with a specific goal of maintaining a duration of negative 10. That means if interest rate rise by 1%, the ETF should rise by 10% (and vice versa).

TBF, RISE and similar ETFs can be used to hedge other bond funds in a portfolio or as stand-alone products to speculate on the direction of interest rates.

Keep in mind, however, that any product that shorts positive-yielding bonds will have to pay a cost to maintain that position over time. This can result in losses even if interest rates remain flat.

YTD Returns For TBF, RISE, TLT, IEF

Long/Short Bond Funds

Another group of ETFs attempts to reduce duration by simultaneously holding long and short positions in bonds. The WisdomTree Barclays US Aggregate Bond Negative Duration Fund (AGND) holds the bonds in the Barclays Aggregate Bond Index and a short position in Treasurys at the same time. The result is a portfolio of bonds with a duration of negative 5.

Once again, AGND could be used as a stand-alone product to speculate on interest rates or combined with, say, another position in the iShares Core U.S. Aggregate Bond ETF (AGG) (which incidentally has a duration of positive 5) to reduce an investor’s interest rate risk.

ETFs that use a similar strategy as AGND’s include the VanEck Vectors Treasury-Hedged High Yield Bond ETF (THHY) and the ProShares High Yield-Interest Rate Hedged ETF (HYHG), which short Treasurys to hedge a portfolio of high-yield bonds. Both target a duration of zero.

YTD Returns For AGND, THHY, HYHG, AGG, HYG

Floaters

For investors who want to do away completely with interest rate risk, a straightforward solution floating-rate ETFs. The iShares Floating Rate Bond ETF (FLOT) holds a basket of bonds with maturities of five years or less. As floating rate notes, the interest rates on these securities resets periodically based on market rates; so if rates increase, the payout increases too (the downside is that rates on floaters will tend to be lower to account for the smaller risk).

Floaters are attractive compared to fixed-rate bonds when rates are expected to increase, but not as attractive when rates are expected to decline.

The PowerShares Senior Loan Portfolio (BKLN) is another type of floating-rate ETF. It tracks an index of the 100 largest bank loans with floating rate coupons. The fund has little interest rate risk, but relatively high credit risk due to its below-investment-grade portfolio.

YTD Returns For FLOT, BKLN, SLQD, HYG

FUTURES CONTRACT SPECIFICATION

LME NICKEL

Futures contracts are an agreement to buy or sell a fixed amount of metal for delivery on a fixed future date at a price agreed today.

Contract code NI
Underlying metal Nickel of 99.80% purity (minimum) conforming to B39-79 (2008)
Lot size 6 tonnes
Prompt dates Daily: out to 3 months
Weekly: 3 out to 6 months
Monthly: 7 out to 63 months
Price quotation US dollars per tonne
Clearable currencies US dollar, Japanese yen, sterling, euro
Minimum price fluctuation (tick size) per tonne Outright Carries
Ring $5.00 $0.01
LMEselect $5.00 $0.01
Inter-office $0.01 $0.01
Last trading day Up until the close of the first Ring the day before the prompt date
Settlement type Physical
Trading venues Ring, LMEselect, inter-office telephone

LME Nickel contract specifications

This is a summary of the contract specifications. For full contract specification details, please refer to the LME Rulebook and for other information, please refer to our disclaimer page.

Note that all contracts are subject to the LME’s rules and regulations and LME Clear span margining.

Nickel Price Surging As Hype Escalates During LME Week

It’s LME Week and there’s cause for celebration in metal markets. European mining stocks rose to a 4-year high as the nickel price surged more than 5% intraday to a two-year high and rose by the daily limit in Shanghai trading today. Metals used in electronic vehicles, like lithium, cobalt, copper and nickel, are hot right now and a focal point of discussion at the LME gatherings. As Metal Bulletin noted, the 2020 event has seen record attendance.

The annual LME Dinner week kicked off in a positive note, with record numbers gathering for the exchange’s keynote metals seminar on Monday October 30. “We have over 900 people over the day here…which is a record attendance,” London Metal Exchange chief executive officer (CEO) Matthew Chamberlain said.

Despite relatively high inventories, big miners and metal traders are becoming increasingly bullish on nickel’s prospects. According to Bloomberg.

Glencore Plc and Trafigura Group Pte are often at loggerheads, but one thing they agree on: the nickel market will be transformed by the rise of electric cars. Nickel sulphate, a key ingredient in lithium-ion batteries, will see demand increase 50 percent to 3 million metric tons by 2030, Saad Rahim, chief economist at Trafigura, said in an interview. While other battery metals like cobalt and lithium have more than doubled since the start of last year, nickel prices have been subdued because of large inventories.

“When you look structurally, we should start to get bullish now,” Rahim said.

“Are you going to be able to meet that demand when the time comes, given underinvestment in the supply side?”

Glencore, which was devastated by the downturn in nickel, is also optimistic, as are some of the analysts, as Bloomberg notes.

(Glencore) told analysts recently that nickel production would need to increase 1.2 million tons by 2030, equal to more than half of current global output, to keep up with demand from the battery industry. Prices are currently more than double what it costs Glencore to mine the metal. It’s a surprising mood change for a market with a disastrous reputation. Nickel was long a thorn for Glencore, which was saddled with unprofitable operations following its takeover of Xstrata. It sold an Australian nickel mine, which Xstrata bought in 2007 for $2.4 billion, for just $19 million in 2020.

“The nickel industry’s been a bit of a dog since about 2007,” Oliver Ramsbottom, a partner at McKinsey & Co. in Tokyo, said by phone.

The battery industry could revive the fortunes of miners more than a decade after nickel collapsed from a peak of $51,600 a ton in 2007

Despite the hype, Bloomberg cautions that there are still naysayers highlighting elevated inventories and the potential for supply to ramp-up faster than currently expected.

Still, some analysts are skeptical that the bullish scenarios will play out. Electric cars are still a niche industry and nickel oversupply remains a threat, with current stockpiles four times bigger than since the start of 2020.

Indonesia has authorized its largest producer to export more nickel ore. The Philippines has also discussed ending a ban on open-pit mining, raising concerns that supply will spike.

“For years, the market has completely dismissed the idea that something positive could happen in nickel,” Ingrid Sternby, senior research analyst at Blenheim Capital Management LLP, said in an interview in London. “With the recent announcements about Indonesia and the Philippines, it’s easy to see why the market is still scary enough for people not to want to be involved…

“You can see the tightness ahead in the nickel market, but my concern is that we’re going to see a lot of value destroyed along the way,” said Colin Hamilton, managing director for commodities research at BMO Capital Markets Ltd.

“If the miners really believe in the EV growth story, the thing to do would be to keep the nickel in the ground until the deficit arrives.”

When assessing the prospects for nickel, it is really two separate markets, nickel alloyed with iron and nickel sulphate used in batteries. Bloomberg expects the latter to progressively trade at a premium to the former.

About half of global nickel production is in the form of ferronickel or nickel pig iron, which is nickel alloyed with iron, making it suitable for stainless steel. Battery makers, instead, use nickel sulphate, produced by dissolving pure nickel metal in sulphuric acid. One hope is that the pricing of nickel pig iron and the high-grade nickel sulphate will diverge in the coming years, improving the fortunes of miners that can produce battery-quality material.

The global nickel market is heading for a deficit once above-ground stockpiles of battery-grade metal are consumed, according to Wood Mackenzie. The question for miners is how quickly the premium for top-quality nickel will emerge.

The nickel alloy versus nickel sulphate certainly adds complexity to analysing nickel. However, while the fundamentals for the latter seem very positive, it makes us slightly nervous when record numbers of participants gather at industry jamborees.

Still, politicians and automakers are increasingly counting on a future of electric cars, attracting traders such as Trafigura.

“Will we see a real breakout in next 12 months? That’s hard to see, but beyond that, structurally this looks to be going up,” Rahim said.

Nickel Trading: 3 Reasons To Invest In The Precious Metal (But Beware The Risks)

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Last Updated on August 16, 2020

Why is Nickel Valuable?

Nickel is a solid, lustrous, silvery-white metallic element that is strong, ductile, magnetic and resistant to corrosion. It also has a high melting point and catalytic properties.

These favorable traits make nickel one of the most widely used industrial metals on earth.

The earliest references to nickel date back to Chinese writings in 1500 BC. However, it wasn’t until 1751 that Swedish chemist Baron Axel Fredrik Cronstedt formally isolated and named the element.

Electron Shell of Nickel via Wikimedia

By the late 1800s, iron and steel manufacturers discovered they could strengthen traditional steel by creating alloys with nickel.

Discovery of new ore deposits in the early 20th century combined with strong demand for steel during World War I and World War II ushered in the modern nickel production industry.

Today mines worldwide extract more than 2.25 million tons of nickel annually.

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In addition, recycling efforts account for additional supplies of the metal.

Over 300,000 products in the consumer, industrial, military, transport, aerospace, marine and architectural sectors use nickel. As a result, nickel has become an essential commodity in world markets.

How Is Nickel Produced?

The supply of nickel derives from two sources: primary production (mining) and secondary production (recycling).

Nickel Rim South Mine via Wikimedia

Mining provides most of the supply, although the United States Geological Survey (USGS) estimates the quantity recovered from recycling in the United States represented 43% of total consumption.

Primary Production

Nickel derives primarily from two types of ores, sulfidic and lateritic. Each type has specific characteristics related to how it is mined:

Sulfidc and Lateritic Ore

Sulfidic Lateritic
Ore Bodies Pentlandite, pyrrhotite, and millerite Limonite and garnierite
Characteristics Usually found with copper-bearing ores Ores contain iron
Nickel Content About 1% About 4%
Geographical Location Mostly in the Canadian Shield and Siberia Tropical regions such as New Caledonia
Deposit Location Deposits are generally found deep underground. Deposits are generally found in varying depths just below the surface.
Mining Method Miners sink vertical shafts into the ground and drive horizontal tunnels into the ore. Large equipment excavates the earth and removes the ore bodies.
Cost of Mining Labor-intensive and expensive to extract Less expensive since mining occurs at the surface.

Processing the ores and separating nickel from them also varies depending on the ore type.

Although sulfidic ores are more expensive to mine, separating the nickel from these ores is cheaper than extracting nickel from lateritic deposits. Additionally, sulfidic ores generally contain other valuable minerals that can be extracted during nickel production.

Nickel Extraction Diagram via Wikimedia

Sulfidic Ore Processing

Separating nickel from sulfidic ores takes place using froth flotation tanks and magnetic processes. These produce two products – nickel matte and nickel oxide. These intermediate products contain between 40 and 70% nickel, but each requires further refining.

Further processing of nickel matte occurs using the Sherritt-Gordon process. With this technique, hydrogen sulfide is added to the molten material to remove copper. This leaves a concentrate of only cobalt and nickel. Solvent are then used to extract cobalt. This leaves a final product with a nickel concentration of more than 99%.

Further processing of nickel oxide occurs using the Mond process. With this technique, nickel reacts with carbon monoxide at temperatures of between 100 and 175 degrees Fahrenheit to produce nickel carbonyl.

At this point, chemists obtain purer nickel from the nickel carbonyl through one of two processes:

  1. Nickel carbonyl passes through high-temperature chambers that decompose it into pure nickel.
  2. Nickel carbonyl passes through smaller chambers that circulate the material at temperatures of about 450 degrees Fahrenheit. This creates a fine, pure nickel powder.

Lateritic Ore Processing

The high iron content of lateritic ores makes smelting the preferred method of nickel extraction. Lateritic ores have high moisture content that requires drying the ores in kiln furnaces.

These kiln furnaces produce nickel oxide from the lateritic ores. At this stage, electric furnaces heat the nickel oxide at temperatures between 2,480 and 2,930 degrees Fahrenheit and produce Class 1 nickel metal and nickel sulfate.

Flash Smelting Nickel Furnace Illustration via Wikipedia

The natural iron content of lateritic ores usually creates a final product after smelting that is ferro-nickel (a combination of iron and nickel). Steel producers can remove impurities such as silicon, carbon and phosphorous from this combination and produce strong steel alloys.

Secondary Production

Very little nickel is recycled to its original elemental state. Instead, scrap products are often recycled into economically valuable materials containing nickel.

For example, it is generally not economically feasible to extract the nickel from scrap stainless steel products. However, recycling these products allows manufacturers to create new stainless steel products that contain nickel.

The Philippines is the largest nickel mining country in the world. However, no single country dominates in production of the metal. Mining takes place in a variety of geographies and countries:

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