By Alex Newman , 30 November 2016
When commodities traders talk about leverage, they are often referring to the day-to-day movements of large futures contracts. As spread-betters know, large wagers on small movements can be very lucrative (as well as damaging).
The neatness of copper’s recent price rally – which we detailed in a chart shortly after the US presidential election – is a useful example of another form of gearing. Rather than derivatives, this leverage concerns equity prices, and shows why higher-cost producers often end up doing a lot better in price rallies.
The reason for this is simple, but sometimes overlooked. If it costs you $10 to mine a tonne of ore, and the price of the ore jumps from $15 to $20, your margin doubles. If it costs me $14 to mine a tonne of ore, a similar increase would send my margin up by 500 per cent. Apply this leverage to companies – whose share prices are often a function of future expected earnings – and the swing can be dramatic.
Returning to copper, we can see the varying effect of this month’s surge in the metal’s price on different cost profiles. The chart below shows this clearly.