In the heady days of 2004-5 several producer Hedge Managers saw textbook opportunities to lock in attractive-looking forward revenue numbers in all metals by launching strategic sell hedge programs at, or close to, historic market highs. Looking forward these programs made sense, but looking backwards, after the market highs were blown away by record growth in Chinese consumption and a huge expansion of investment in commodity indices, many of these programs, which capped the upside in commodity-based revenue, were deemed disasters. Career risk management concerns caused professional Hedge Managers to back away and over the period 2006-11, producer Strategic Hedging almost became extinct.

One man’s inventory is not another’s, but If metal price volatility has weaponized your inventory so that its value swings lay waste to your financial results, then it’s a problem you need to get a grip on. Many metal processing businesses face this exact issue but find that quantifying the price exposure it contains is trickier than assumed. Production people measure metal inventory by tangible presence, accountants deem it to be what’s under operational control but risk managers must know volumes based on pricing events (Stock-At-Risk SAR). Rarely if ever are the three equal either; in fact they can be significantly different. We’ve seen operations with enough physical and accounting inventories to make an asset manager cringe, but when it came to SAR, they were inventory negative. Strange but true, and the reverse is just as possible.

You know what they say are the three most important factors for successful property owning – well it is the same with hedging metal units in inventory, or, more correctly, Stock-At-Risk – not location but optimization. Transactional, Cash Flow Hedging should be relatively straightforward so that while the expression “Perfect Hedge” is not always practically possible, it is the right way to aim. Not so for hedging Stock-At-Risk. Neither automatic execution nor perfection is possible. The use of informed disciplined management judgement is the key ingredient and the goal is to be able to say after five years that the overall financial outcome has been significantly better than doing nothing.

Inventory hedging is the orphan of the commodity price risk management business. The source of more diametrically opposed opinions and different practices than any other topic, it makes us wonder where to begin. At the beginning, of course, but hold onto your hats it is a twisting and rather long ride! We will be following up with a second blog on the more nitty-gritty issues of, variable quotational periods, hedge roll-overs, use of discretion and accounting treatment, so watch this space.

It is a truth universally acknowledged, that a metal price in possession of a daily reference, must be in want of an average. Or so it seems in the physical metals world. In the course of our adventures through the ecosphere of commercial contracts and pricing principles we see averages employed everywhere. And why not? They’re simple, easily applied and save administrative overload. And anyone who didn’t grow up under a rock knows exactly how to use them. Or maybe not. For in the world of business affairs it is practically certain that every concept properly applied will surely attract an indiscretion. We present four opportunities.

“Isn’t our hedging supposed to solve this?” Each month-end, your stressed-out accountants sweat to explain your company’s volatile P/L and risk reconciliations that show the hedge results are failing to offset company exposures. No one can blame the futures brokers either – hedge transactions have been reconciled and were executed as specified. The problem must be somewhere else – possibly buried in the hedge targets or potentially in the reporting? The immediate task is to identify the glitches before bad information leads to faulty decisions.