Going for gold

UBS has won top spot in this year's metals poll, pushing last year's winner, Barclays Capital, into second place. Goldman Sachs finishes in third position and HSBC in fourth, in a year characterised by volatile metal prices. By Mark Pengelly, with research from Xiao Long Chen

UBS has topped the metals categories in this year's Energy and Commodity rankings, taking 12.3% of the vote overall. The Swiss bank leapfrogged three places from last year's fourth spot, pushing the winner of the 2006 metals survey, Barclays Capital, into second position with 11.6% of the vote. HSBC once again dominated the gold and silver categories, while Mitsui Global Precious Metals retained its stranglehold over the platinum and palladium markets (see leaderboard on page 58).

It's been a rollercoaster year for the metals sector. Following on from gains in 2005, prices hit record highs in May last year. The active month copper futures contract for three-month delivery on the London Metal Exchange (LME) reached an all-time high of $8,600 a tonne on May 11, up 94% from the beginning of the year. LME prices for active month high-grade aluminium did much the same, spiking at $3,185 a tonne on May 11 - levels unseen for 18 years.

However, these markets have experienced major corrections. By June 13, the active month copper contract for three-month delivery had plummeted by 24% from its May peak, while high-grade aluminium had fallen by 23% over the same period. As of January 22, copper was trading at $5,620 a tonne on the LME, while aluminium was at $2,757 a tonne.

The bull-run in 2005 and early 2006 had attracted a broader spectrum of investors to the metals markets - in particular, hedge fund managers and pension funds keen to diversify their portfolios. However, the tumble in prices has prompted fears that institutional investors might begin pulling out of the market. In fact, price volatility did have an effect on liquidity in late 2006, concede dealers.

"Naturally, when markets move violently liquidity can decrease, and this was certainly the case at times in the metals markets during 2006," says Ashraf Rizvi, London-based global head of metals at UBS.

Nonetheless, returns from many base and precious metals still look healthy over the year. Despite the sustained fall in copper prices since last May, investors would still have made a 43% return between January and December 2006. Nickel also performed strongly, with prices rising by 144% over the same period. Even aluminium, which did not perform as well as some of the other metals, would have given investors a 23% return.

This combination of healthy returns and price volatility has actually created an attractive trading environment for investors, says Rizvi: "We have certainly seen clients move from being involved in foreign exchange, fixed income or equities crossing over and now transacting in the commodities market." The bank has seen increased demand for metals among corporate clients, pension funds, hedge funds and high-net-worth individuals, even after the correction in prices, Rizvi adds.

UBS dominated the metals portion of the Energy and Commodity rankings this year, winning the gold options and cash to three-month silver categories, garnering 19.8% and 15.1% of the vote, respectively. In all other precious metals categories, UBS was ranked in second place.

Such a strong showing in precious metals is not new for the bank, which was also ranked within the top two for all precious metals categories in 2006. What has made the difference for UBS this year is its performance in base metals. Last year, it finished fifth in the cash to three-month copper, copper options, aluminium options and other base metals options categories, while being unranked everywhere else except base metal exotic structures.

Apart from dropping one place to joint-third in the base metals exotics category, UBS improved its standing dramatically this year. It reached second place in the cash to three-month aluminium and cash to three-month other base metals categories, and came third in copper options, copper forwards/averages/swaps, aluminium forwards/averages/swaps, other base metals options and other base metals forwards/averages/swaps. In each of the other remaining categories - cash to three-month copper and aluminium options - the bank improved by one position on 2006, finishing fourth.

Behind it in second place this year is Barclays Capital. Although it dropped from first place in 2006, the bank maintained its strong performance in base metals. Among those 10 categories, Barclays racked up no less than seven first places, including cash to three-month copper, aluminium and other base metals. While the UK bank was not ranked in any of the silver categories, it did come third in gold forwards/averages/swaps and fourth in the cash to three-month gold and cash to three-month platinum and palladium categories.

Benoit de Vitry, London-based head of commodities, emerging market rates and quantitative analytics at Barclays Capital, says the bank has seen increased activity from a wide variety of clients this year. "There is a continued increase in the number of players. Additionally, it is fair to say that from consumers to producers to investors, every aspect of the client base has increased activity."

Although metals prices have dropped off sharply over the past nine months, de Vitry believes the entry of new investors into the sector is not just a flash in the pan. "There's more and more money coming into the market. And that's not a short-term trend - some of these players will continue to invest for a very long time," he adds.

Not only has this broader spectrum of investors been getting much more involved with metals, they are also taking advantage of a wider array of products. De Vitry says investors are now able to employ more sophisticated investment strategies in metals, including relative growth and relative value plays.

Finishing in third place this year - as it did last year - is Goldman Sachs with 9.4% of the overall metals vote. The US dealer topped the aluminium options, copper options and base metal exotics categories, and finished second in copper forwards/averages/swaps, aluminium forwards/averages/swaps, other base metals options and other base metals forwards/averages/swaps. The firm also came third in cash to three-month copper, cash to three-month aluminium and cash to three-months in other base metals.

While dropping from second to fourth place overall this year, HSBC still dominates gold and silver categories. It won four out of six precious metals categories - cash to three-month gold, gold forwards/averages/swaps, silver options and silver forwards/averages/swaps. In gold options and cash to three-month silver it ranked second - in both cases coming close to UBS.

Precious metals presented a different set of challenges and opportunities to dealers this year, but gold and silver did follow base metals to a certain extent in May. Active month gold for three-month delivery on Comex rose to $757 an ounce on May 11, up 34% from January 2006. The active month silver contract for three-month delivery, meanwhile, gained 58% over the same period, reaching $15.02 an ounce on May 11. Both subsequently fell - gold prices had plunged 22% by June 13, while silver had fallen by 34%. Throughout the rest of the year, however, the two metals remained relatively stable. As of January 22, gold for three-month delivery was trading at $640.30 an ounce on Comex, while silver was at $13 an ounce.

Ben Welsh, HSBC's head of global markets for North America, says gold and silver have, like base metals, seen a more varied range of investors entering the market over the past year. Unlike base metals, though, many of the new participants are retail investors. In particular, exchange-traded funds have helped support the market for gold by making it easier for retail customers to gain exposure to the metal. "The diversity of people participating and investing in this space, and the reintroduction of the retail investor into the gold market, has provided some stability," says Welsh.

Elsewhere, Mitsui Global Precious Metals remains the dominant force in the platinum and palladium categories, winning both the cash to three-month and forwards/averages/swaps groupings.

While both platinum and palladium tracked the rise and fall in other markets in May, platinum in particular proved its distinctiveness in 2006. The metal suffered a particularly high bout of volatility in November, which saw prices for the active month platinum contract on the New York Mercantile Exchange rise by 15%, from $1,068.10 an ounce on October 24 to $1,231.30 an ounce on November 20, before falling by 10% to $1,109.10 an ounce on December 18. This seesawing was widely attributed to trading by speculative investors.

Tim Gardiner, Mitsui's New York-based president and chief executive, says supply and demand dynamics require platinum and palladium traders to have deep market knowledge and the capacity for physical delivery. "I think some of our competitors may struggle because they treat platinum and palladium like gold and silver or copper and lead," he adds.

Platinum comes from a limited number of sources and has few industrial applications - leading to finely balanced global supply and demand, explains Gardiner. While investors can build up positions in palladium fairly easily, the relatively small scale of the market means prices can move against investors rapidly. And Gardiner says the volatility in November was testament to this.

The rise in metals prices in 2005 and early 2006 had led some analysts to suggest a speculative bubble was building in the commodities market, driven by an influx of passive commodity index investors looking for quick gains in a rising market. However, dealers say activity from traditional participants, such as producers, specialist trading firms and brokers, still dwarfs the flows resulting from index investment - in fact, many hedgers increased their activity in 2006. HSBC's Welsh says more producers and consumers have entered the gold and silver markets as a direct response to increased volatility. And UBS' Rizvi tells a similar story in base metals. "Certain consumers or producers have been a little bit frustrated by the market and the increased volatility. But many have taken very good advantage of it by selling base and precious metals at much higher prices than current levels," he says.

All in all, optimistic predictions surround this increasingly sophisticated market. Dealers say the metals markets are broader, more liquid and more sophisticated than ever before. However, Barclays Capital's de Vitry sounds a note of caution about the capacity for significant growth in the metals markets over the next few years. "You can't just wave your magic wand and get a mine up and running in a couple of weeks. It takes five to seven years," he warns.

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