FX Markets Drive Increased Hedging Opportunities in Copper Trades

In this article:

  • China is the largest participant in global copper markets.
  • The exchange rate between RMB and USD plays a key role in this international trade.
  • Futures contracts are widely used to manage the risks in both the copper and FX markets.
  • Margin offsets offered by CME Group between the two markets greatly improve the efficiency of this hedging strategy.

The global copper market has grown substantially in recent years, with refinery production estimated at 25 million metric tons per annum. China is by far the largest producer of refined copper, and whilst there is significant mining capacity within China, much of the ore and concentrate being refined there is imported. In fact, China accounts for nearly 50% of the global copper imports. In addition, China is a significant trade hub for refined copper, downstream products, and scrap. As the international copper trade is conducted primarily in US dollars, the changing value of the Chinese renminbi (“RMB”) versus the US dollar (“USD”) plays an important role in the economics of this trade. The RMB traded onshore in China is referred to as the Chinese Yuan (CNY) whereas offshore traded RMB is referred to as CNH. For purposes of hedging RMB exposure, international market participants generally tend to use CNH, especially if the hedging is done offshore.

Commodity exchanges around the world enable the trading and risk management of copper. Merchants and traders use these markets to manage risk in physical transactions, and to identify and overcome price differentials in location and delivery timing. The COMEX Copper futures contract is one such global benchmark. Similarly, the CME Chinese renminbi FX Futures contract (“USD/Offshore RMB (CNH)”) is a key tool for managing the FX risk between the two currencies.

Traders with positions in COMEX Copper futures and requiring an RMB hedge can also enjoy significant overall margin savings by executing the FX hedge using CME USD/Offshore RMB (CNH) futures for this purpose.

At the time of writing, margin offsets are 50% between USD/Offshore RMB (CNH) futures and Copper futures. Prices and margin levels change, but at the time of writing, this offset means that the margin on a COMEX Copper futures position fully covered for FX risk by a CME USD/Offshore RMB (CNH) futures position would be 30% lower than the margin on the standalone COMEX Copper futures position.

Volatility in USD/CNH FX rate creates price variation for USD- and CNH-priced copper markets

Volatility in USD/CNH FX rate creates price variation for USD- and CNH-priced copper markets

Source: CME Group. Active month COMEX Copper futures settlement price; converted to CNH using CME USD/CNH futures settlement price.

During the COVID-19 pandemic, and the period of increased global uncertainty it has created, prices for copper have been volatile. From the lows in March 2020, prices in USD had risen 65% by the end of the year. However, over the same period, there has been an appreciation in the value of the CNH in relation to the US dollar, moving from around CNH 7.1222 per USD to CNH 6.5074 per USD as measured by the spot rate for USD/CNH. This latter effect has somewhat softened the price increase for Chinese copper importers, as the COMEX price expressed in CNH has increased from CNH 33,280 to CNH 50,410 per metric ton, which is approximately a 51% increase, as compared to the 65% increase in USD terms.

Such volatility in the FX markets highlights the uncertainty that importers face. It is worth noting that any move in the FX rate that benefits an importer – i.e., an appreciating CNH versus USD since the importer is buying in USD – will conversely have a negative effect on the exporter.

CME offers futures contracts on the RMB FX rate, the USD/Offshore RMB (CNH) futures contracts, which can be used to manage this FX exposure. These contracts are cash settled with reference to the USD/CNH spot rate published by the Treasury Market Association in Hong Kong. Each futures contract is for US $100,000, which is comparable to the USD value of a COMEX Copper futures contract of approximately US $102,000 at the time of writing.

Below is an example of how the CME USD/Offshore RMB (CNH) futures contract can be used to hedge the FX component of a copper delivery into China.

Scenario

In October, a copper trader has organised a shipment of copper scrap into China with loading in two months and delivery three months forward. Using copper futures markets, the trader can hedge the load out cost in US dollars. It is assumed that the delivery price is fixed in RMB. The return from the trade is exposed to the FX rate between the US dollar and the Chinese renminbi. As with the copper price, the FX risk can be hedged with futures.

Transaction information

Copper quantity

2,500 metric tons (~5,511,557 pounds)

Current COMEX Copper December futures price

USD 3.2250 per pound

Copper scrap load out price

COMEX futures price minus $0.10 per pound

Effective delivery price

CNY 48000 per metric ton (~48,000 CNH)

Current CME USD/Offshore RMB (CNH) January futures price

CNH 6.7200 per US dollar

CME USD/Offshore RMB (CNH) futures contract size

USD 100,000

The exposure to the copper price can be hedged with COMEX Copper futures. With each futures contract representing 25,000 pounds of copper, buying 220 futures for the December contract month will effectively hedge this position with respect to the price of copper.

 

The trader can undertake a similar exercise to hedge the delivery value in China. With these hedges in place, the effective acquisition cost is US$ 3.1250 per pound, and the agreed effective delivery price is CNY 48,000 per metric ton. This is a potentially profitable trade. However, the trader has a three-month period of uncertainty relating to FX risk. Although the settlement amount is in CNY (onshore), the trader could effectively hedge the FX Risk offshore using CNH instruments as the two currencies are closely linked and the conversion rate is very close to one.

The FX component of the transaction can be hedged using the CME USD/Offshore RMB (CNH) futures contract (Globex product code CNH). To determine the hedge transaction required, the trader needs to determine whether to buy or sell futures, and the quantity to be transacted.

Even though the CME USD/Offshore RMB (CNH) futures contract is a cash settled contract, it provides hedging for FX risk linked to USD/CNH exposure just like a physically delivered contract; buying one contract is equivalent to buying USD in exchange for CNH. Selling the futures is equivalent to selling USD in exchange for CNH.

In the current example, it is assumed that the price of the shipment is fixed in CNH, and that the trader has a base currency of the US dollar and will wish to convert the Chinese renminbi received on delivery of copper into US dollars. The associated FX risk exposure can be hedged by buying CME USD/Offshore RMB (CNH) futures contracts. These futures should be bought to implement the hedge and sold to close out the position once the FX hedge is no longer required. This will create a futures payoff on the hedge being the difference between the price paid to open and the price at which the hedge is closed out at. Trading in the USD/Offshore RMB (CNH) Futures terminates on the second Hong Kong business day prior to the third Wednesday of the contract month1. This would make January the appropriate futures contract month to hedge this transaction since the CME USD/Offshore RMB (CNH) futures contract is listed and active in consecutive calendar months.

The number of FX futures needed to hedge the transaction can be calculated by considering the currency exposure. With the copper delivery, the trader will expect to receive CNH 120,000,000.

 

The futures price, quoted in Chinese renminbi per US dollar, is CNH 6.7200 which is the equivalent of US$ 0.148810 per Chinese renminbi. At this exchange rate, the expected income will be US$ 17,857,143. The contract size of the CME Chinese Renminbi futures contract is US$ 100,000; therefore, to hedge the FX exposure, the producer needs to buy 179 futures.

 

With long positions in both COMEX Copper futures and CME USD/Offshore RMB (CNH) futures, the trader will also take advantage from a reduced margin on the combined position due to the margin offset made available between the contracts by CME Clearing.

We can examine what might happen to this hedged position in different outcomes.

Outcome 1: An appreciation of the RMB

An appreciation of the RMB versus the USD can also be viewed as a decrease in the value of USD, measured in RMB. In this example, we assume an appreciation of the RMB such that the price of the January futures contract goes from CNH 6.7200 to CNH 6.4700, which represents an appreciation of 3.9%. This can also be seen as a change in value from US$ 0.148810 to US$ 0.154560 per RMB.

With the copper delivery price fixed at CNH 48,000 per metric ton, the sale proceeds of CNH 120,000,000 have a US dollar value of US$ 18,547,141, which is greater than expected had the exchange rate not changed. This improved outcome is offset by a loss made on the FX futures position. Overall, the cashflow has been maintained in line with expectations, which is the purpose of the hedging strategy.

 

Physical copper

Physical US dollar cashflows

Chinese Renminbi futures

October

 

Expected US$ 17,857,143

Buy 179 lots of January CNH futures @ 6.7200

January

Sell 2,500 metric tons @ CNH 48000 / metric ton

Actual US$ 18,547,141

Sell 179 lots of January CNH futures @ 6.4700

Net result

 

+ US$ 689,998

- CNH 4,475,000

(= - US$ 691,654)

Outcome 2: A depreciation of the RMB

A depreciation of the RMB versus the USD can also be viewed as an increase in the value of USD, measured in RMB. In this example, we assume a depreciation of the RMB such that the price of the January futures contract goes from 6.7200 to CNH 6.9700, which represents a 3.6% depreciation. This can also be seen as a change in value from US$ 0.148810 to US$ 0.143472 per RMB.

With the copper delivery price fixed at CNH 48,000 per metric ton, the income of CNH 120,000,000 in this scenario has a US dollar value of US$ 17,216,643. This is lower than expected, and the decline is enough to wipe out any potential profit from the trade, even before transportation costs are factored in. To compensate though, the FX futures hedge position records a gain of CNH 4,475,000, which maintains the overall return from the transaction.

 

Physical Copper

Physical US dollar Cashflows

Chinese Renminbi Futures

October

 

Expected US$ 17,857,143

Buy 179 lots of January CNH futures @ 6.7200

January
 

Sell 2,500 metric tons @ CNH 48000 / metric ton

Actual US$ 17,216,643

Sell 179 lots of January CNH futures @ 6.9700

Net Result

 

- US$ 640,500

+ CNH 4,475,000

(= + US$ 642,037)

In the example given above, the trader’s base currency was assumed to be USD and the price of the shipment was assumed to be fixed in RMB. Similar hedging strategies would apply for the case where the price of the shipment was determined in USD and the trader’s base currency is RMB. In the latter case, the trader would need to hedge the purchase of USD to settle the payment obligation and this could be hedged once again by buying CME USD/Offshore RMB (CNH) futures contracts as in the example shown.

The FX hedging strategy shown for trade in physical copper is also applicable in cases where a trader has the FX exposure in RMB arising from positions in financial derivatives denominated in different currencies.

Conclusion

Copper markets remain volatile and hedging price risk remains an important consideration. In addition, the volatility in foreign exchange markets can also be an unpredictable factor that firms are looking to hedge. By hedging foreign exchange risk, companies can stabilize future cash flows which in turn creates greater confidence in business performance.

The CME Group suite of metal futures sit alongside a number of key foreign exchange futures contracts, which together provide participants with effective hedging tools to manage growing risks in the sector.

In addition, traders with positions in CME USD/Offshore RMB (CNH) futures and Copper futures can receive significant margin savings of 50%.

Salient features of the futures contracts discussed in this article:

Contract

Copper futures

Chinese Renminbi futures

Exchange listing

COMEX

CME

Commodity code

CME Globex: HG
Clearing: HG

CME Globex: CNH
Clearing: CNH

Contract size

25,000 pounds

USD 100,000

Quotation

US dollars and cents per pound

Offshore Chinese Renminbi per US dollar

Tick size

$0.0005 per pound
$12.50 per lot

0.0001 per USD
10 CNH per lot

Listed months

24 consecutive calendar months and any March, May, July, September, and December in the nearest 63 months

13 consecutive calendar months plus 8 March quarterly cycle contract months

Last trading day

Trading terminates at 12:00 Noon CT on the third last business day of the contract month

Trading terminates on the second Hong Kong business day prior to the third Wednesday of the contract month at 11:00 a.m. Hong Kong local time

Settlement method

Delivery

Financially settled

Final settlement price

Delivery at the contract settlement price on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but not later than the last business day of the current delivery month

The “CNY CNHHK” (CNY03),” which is the “Offshore Chinese renminbi per U.S. Dollar” spot exchange rate, for settlement in two business days, reported by the Treasury Markets Association, Hong Kong (www.tma.org.hk)


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