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Introduction to Metal Exchanges
By Ingrid Goodspeed, Associate Director Deloitte

n February 2005 Lulu Xingwana, Deputy Minister of Minerals and Energy, announced that “Johannesburg could become the centre for a Pan-African Metals and Minerals Exchange trading diamonds, gold, platinum, cobalt, aluminium, ferro-alloys, gemstones, titanium oxide and copper”. An independent consultancy, Virtual Metals has been appointed to undertake a study into the feasibility of establishing such an exchange. The objectives of this article are to outline the global environment into which the Johannesburg Metals Exchange will be launched and describe the key elements that determine the likelihood of success for a metals exchange initiative. Since each metal has unique market conventions, this article will focus, where appropriate, on gold trading.

1. What is a metals exchange
A metals exchange is a centralized market in which metals are bought and sold. The exchange not only allows metals to be sold spot or for delivery at some specified time and place, but may include a market in futures. The futures market will allow participants to avoid the effects of price fluctuations by buying / selling for forward delivery at a specific price that will not be impacted by changes in the spot price.

Metals exchanges provide a mechanism

  • to improve the quantity and quality of information – including price information - to all those active in the production, trade, processing and consumption of metals;
  • reduce the cost of identifying market sources,:
  • make available an efficient system of grading and improve the reliability of quality standards;
  • give security in trade transactions;
  • facilitate access to relatively cheap metals finance; and
  • assist in price risk management.

2. Global Metal Trading
The global trade in metals consists of over-the-counter (OTC) transactions in spot, forwards, options and other more-complex derivatives together with exchange-traded futures and options. Exchange-traded futures and options contracts are standardised so that each contract traded is of the same quantity and purity of metal as all other contracts in that commodity. In addition the place of delivery – if delivery is made – is specified, as is the period within which delivery must take place. Generally less than 1% of futures contracts come to delivery as the majority of clients close out their futures positions before expiry date and deliver or take delivery through OTC channels - futures and options being used to hedge price risk. On the other hand, OTC forward or options contracts may be of any size or delivery date subject to the agreement reached between the counterparties to the agreement.

The forward or future price is a function of the underlying spot price, prevailing interest rates in the money markets and costs such as insurance and storage.

Table 1 shows the most important metals exchanges in the world and the metals traded on them. Gold and silver are traded on all exchanges except London Metals Exchange and Tehran Metals Exchange.

Table 1: Metals exchanges and metals traded
Exchange Gold Platinum Paladium Silver Copper Aluminium Lead Nickel Tin Zinc
Chicago Board of Trade
x
x
Dubai Gold & Commodities Exchange
x
x
Istanbul Gold Exchange
x
x
x
London Metal Exchange
x
x
x
x
x
x
National Commodity & Derivatives Exchange Limited (India)
x
x
x
x
New York Mercantile Exchange: Commodity Exchange Division
x
x
x
x
Shanghai Futures Exchange
x
x
x
x
x
x
x
Tokyo Commodity Exchange
x
x
x
x
x
x
Tehran Metals Exchange
x
x
x

Table 2 shows the number of futures and options contracts per annum traded on the major global metal exchanges. The two main exchanges for gold and silver are Comex (the Commodity Exchange Division of New York Mercantile Exchange) and Tocom (Tokyo Commodity Exchange). In 2004 the average daily turnover represented by futures contracts traded on Comex and Tocom was 9.7million ounces of gold and 101.4 million ounces of silver.

Table 2: Metal Exchanges and contracts traded
Exchange Instrument Source Data Number of contracts ('000) % Total Futures % Total Options Gold Futures % Total Futures
Chicago Board of trade Futures Nov-04
727
0.4
510
1.5
London Metal Exchange

Futures
Options

Dec-04
67 172
4 612
39.7

45.2
New York Mercantile Exchange: Futures Dec-04
24 916
14.7
16 061
Commodity Exchange Division Options Dec-04
5 527
54.2
Tokyo Commodity Exchange

Futures
Options

Dec-04
Dec-04

74 447
64

44.0


0.6

17 386
51.2
Shanghai Futures Exchange Futures Feb-04 1 880 1.1      
Totals Futures
Options
 
169 142
10 203
100.0
100.0
33 957
100.0
179 345

The bulk of global trade in gold and silver takes place over-the-counter (OTC). London is the largest global centre for OTC transactions followed by New York, Zurich and Tokyo. Although the physical market for gold and silver is distributed globally, most OTC transactions are cleared through London. In December 2004 the average daily volume of gold and silver cleared through the London Bullion Market Association was respectively 15.4million ounces (USD6.8billion) and 102.2million ounces (USD730million).

3. Characteristics of a successful metals exchange
The following are characteristics of a successful metals exchange, indeed of any exchange:

  • Liquidity: The real asset of any exchange is liquidity. The larger the liquidity pool the more attractive the market is to participants;
  • Open participation: The market should be open and accessible to many participants – investors speculators, producers and consumers, corporate treasurers, commercial and investment banks, brokers / dealers and individuals as part of their financial management strategy;
  • Standardised systems: The exchange should have standardised and robust systems for trading, clearing , settlement and custody;
  • Sound clearing systems: The clearing system of the exchange should provide assurance to all participants that counterparties to each trade will make good on the contract;
  • Standardised contracts: The exchange should have standardised contracts in terms of quality and quantity specifications and delivery points; and
  • Good governance: The exchange should be well managed with sound rules, governance and risk management.

4. Conclusion
Given the current global competitive environment, the question – is there room for another metals exchange? – must be a key question to be answered by the feasibility study into the establishment of Johannesburg Metals Exchange. Above all the metals exchange should not be a status symbol but should meet the needs of its constituents and allow those active in the underlying metals markets – whether producers, traders, manufacturers or consumers – to reduce transaction costs and improve the manner in which they operate. Failing this there is little chance the exchange will survive.

Nonetheless a metals exchange has the potential to contribute to the economic development of Southern Africa and the well-being of its population.

Sources and bibliography
UNCTAD Secretariat, 2001, Overview of the World’s Commodity Exchanges, www.unctad.org;
UNCTAD Secretariat, 1997, Emerging commodity exchanges: from potential to success, www.unctad.org;
International Financial Services, London, 2005, Bullion Markets, www.ifsl.org.uk;
Websites of the exchanges;
www.lbma.org.uk;
www.gold.org.

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