The Inventory Hedge

The Inventory Hedge

Hedging with DGCX Steel Rebar Futures

Hedging is the use of the futures market to manage price risk arising from a position in the physical market. It tends to involve a physical market participant taking a position in the futures market equal and opposite to that held in the physical market. Alternatively it may involve taking a position in the futures market in anticipation of taking the same position in the physical market. By way of example, below we will look at hedging with futures from the perspective of a scrap-based producer and a contractor. Each scenario will commence with the following fundamentals. • The DGCX steel futures market shows prices 6 months forward • Each steel futures contract is for 10 mt of BS 4449 rebar • The date is June 5th

Inventory Hedge

This example could apply to any participant in the rebar supply chain with unsold inventory and worried about falling market prices. The participant might be: • A scrap-based producer holding 5,000 mt of unsold scrap and/or billet and/or rebar • A re-roller holding 3,800 mt of unsold billet and/or rebar. • An iron ore-based, or HBI-based, producer sitting on 2,400 mt of unsold inventory of raw materials and/or billet and/or rebar. • An international trader who has an unsold 1,000 mt from a larger allocation of billet and/or rebar now coming ready. • A local stockist with 5000 mt of rebar inbound, or in stock, of which 730 mt remains unsold. Let’s say that, apart from isolated examples, the markets – scrap / billet / rebar – are showing signs of deteriorating, both in price and tonnage. And contrary to market forecasts / opinion, the party holding the inventory thinks prices will worsen even further Let’s use the first of these examples – the scrap-based producer – to explain the principles of the inventory hedge.

Remember, its still June 5th, and no-one is willing to buy for July / August because they see prices falling. But let’s say our producer locates 2-3...