Hedging commodities, monetary policy and crude oil fluctuations

Freight up hello and welcome back to Freight Up, FIS's freight and commodity Podcast.

I'm Davide and together with Jess, we will be your hosts as we navigate the seas of freight and commodities.

So we have a great episode for you before we go on our summer break and we have lots of topics to discuss.

That's true.

So a lot has happened in the last couple of weeks.

To start with today, we have Samuel Basi, who is the founder of Perfectly Hedged Consultancy.

He's also a former Trafigura metals trader and he'll talk us through his experiences and how to hedge.

Then we have Carlo Boffa from Politico who'll guide us through the latest developments in terms of macro and monetary policy.

And lastly we have Archie Smith who will tell us about what's happened over the past couple of days in the oil markets.

So as per usual, let's start with the main macro news of the past two weeks.

So consumer prices in the United states rose by 2.8% year over year.

In May, the headline annual inflation rate increased for the first time in four months to 2.4%, up from 2.3% in April, its lowest level since 2021, but still below market expectations of 2.5%.

In China, retail sales grew by 6.4% year on year in May, accelerating from 5.1 in April and surpassing market forecast of 5%.

The UK's annual inflation rate eased slightly to 3.4% in May, down from 3.5% in April and in line with expectations.

Meanwhile, Japan's inflation rate declined to 3.5% in May from 3.6% in the previous two months, marking its lowest level since November.

And now we have Samuel Bassi.

How are you, Sam?

I'm doing well, thank you.

Jessica.

How are you doing?

I'm very good too.

So I wanted to start with bit of a provocative question.

We had a seasoned freight trader talk to us the other day and he was saying that you're not really seeing a one to one hedge anymore, that it just adds more risk to the trade.

What's your take on that view?

Given my business is encouraging the hedge, I don't fully agree.

I would say that there are markets where the underlying commodity is not highly correlated to the exchange price of that commodity.

And in that case you can be creating risk by hedging using that instrument instead of mitigating risk.

But for the most part, we're really fortunate, especially in base metals where we have multiple exchanges that are highly liquid and the derivative instruments are you Know, highly correlated one for one with the physical.

In those examples, hedging one for one is what you should be doing because you can fully mitigate that underlying price volatility so that it doesn't impact your profits on your physical trading.

In a market where that isn't feasible, there may be a lack of liquidity or a product mismatch.

How do you quantify the cost of the imperfection versus the cost of inaction?

So I mean, the first thing you have to do is identify what that correlation is.

Are we talking about a 90% correlation where there's a 10% kind of mismatch, or is it a 20% where we would actually be creating an 80% risk profile?

So once you've done that and kind of made that decision as a company, are we going to try and mitigate this underlying price risk?

And if the answer is no, then you have to get a bit creative.

Are we going to try and you know, back to back these physical contracts so they're pricing at the same time or we, we limit as much of that exposure as we can do.

We hedge certain percentages.

So when you look at scrap contracts where you don't want to hedge 100% of the volume because it's only got a certain percentage of metallic contained, we're going to hedge our payable content and that's how we're going to mitigate that risk.

So it really depends on the product.

You know, there are some commodities where there just there isn't a liquid exchange.

You can approach the OTC market and kind of rely on your relationships with brokers to try and find not necessarily one of your clients, but one of their clients that's looking to offset that same risk on that same commodity.

But it can be really tricky to fully mitigate your price risk on those commodities.

Where you are in a liquid market.

Do you have certain types of clients that either overhedge or under hedge due to maybe fear or misunderstanding?

I think we, we run into a lot of clients who because of their misunderstanding and approach risk in the best possible way and we try and guide them to the most appropriate way of mitigating their price risk.

So yeah, I think under hedging, over hedging, not looking at hedging the way they should is fairly common in the industry.

I think with Algos starting to move into the market, presumably this will dominate the futures liquidity.

How will this change how you execute a hedge now versus say 15 to 20 years ago?

As you mentioned, Algos are moving into the market some People view them as good because it does provide so much liquidity.

Other people view them as negative because they can just make prices swing very drastically and in a very short space of time.

The advantage to hedging physical is that most of the contracts are executed on an official settlement where there is a ton of liquidity.

And so you're not really going to see those price distortions.

On the other hand, you do have some contracts where you're pricing them live just on a screen price that can be off for a customer has a level order or a price target.

And you need to navigate the either illiquid market or the price moving rapidly away from their level.

You might need to strategize a bit about how you place that trade.

Do you stay away from big figures where you're fairly confident the price is going to bounce away from that or not actually reach it because an algo is going to come in and either keep it below that or move it above very quickly?

You can look to iceberg your trade so that you're not showing the market all of your order at once.

But then that does have downsides because iceberg trades, the way they're filled, you know, you only show 10% of the order, but then once it's been filled, the next 10% moves to the back of the queue.

So it's a way of assessing the client's needs, how their approach to risk is, and then what the specific market is in terms of how we're going to execute.

Can you share any particularly creative or bold hedging strategies that you used while you were at GMI or that you've seen in the market?

Anything that really stands out when you're.

Looking at those more illiquid markets, like I said, using the OTC markets to try and find kind of offsetting clients.

You know, when you look to the scrap market, which with the green energy transition is becoming and you know, a very important part of metals, you know, the metals market using those markets where it's not a 100% correlation and strategizing, for example, we had a situation where we were trying to decide when to hedge battery scrap.

Battery scrap is not 100% correlated, and in some instances it's negatively correlated to the price of the lme.

So coming up with solutions over when is the best time to hedge that and lock in that margin and at the same time, how much risk do we want to leave on the table utilizing stop losses, utilizing limit orders to really try and capitalize on the market using iceberg trades like I mentioned just ways to mitigate that risk but also allow upside exposure.

You know, we have very recently, especially given how much geopolitical influence there's been on the prices.

I've been having a lot of conversations with people about what to do on that weekend price exposure, because Belame, for example, and cme, both markets are closed at the weekend, but there are tweets being fired out.

There are a lot of impacts that happen over the weekend.

And how to navigate the fact that if, even if you're using stop losses, the market could gap open on Monday morning, how to go about mitigating that kind of exposure or recently we had a bank holiday in the uk, but the CME was open.

So if you had LME positions on copper, for example, discussed with some clients where they need to be asking their broker to utilize the CME while it's still open so that they are capping their risk, so that if the LME does open and it gaps up or gaps down depending on their position, they're not fully exposed to that.

So my next question was going to be the use of options and hedging strategies.

We personally find that some of our physical clients are harder to convince in terms of the use of options.

And it's a good option in many points, especially if you wanted to use something like a zero cost collar to mitigate the cost of the trade.

Why do you think clients would be hesitant to use them?

And is that something that you would recommend?

It definitely depends on the client.

I think the world of options is often viewed as a bit murky.

It's very kind of viewed as purely speculative and it's not taken advantage by companies when it can actually offer some fairly good solutions to their problem.

Yeah, I think the main reason is that you say options to someone and they think that, you know, they need to have an option specialist and a dedicated desk and that there's going to be a ton of exposure.

Whereas they can provide solutions to companies who, let's say they are prepared to run a little bit of price risk and they're willing to pay a premium even on something as simple as, you know, buying a pert or buying a call whereby they have that insurance policy should prices not go in their favor, but they do now have that Runway for prices to move up or down, depending on their position, to actually increase their P and L.

Obviously options strategies can be incredibly complex and you do need to really have someone monitoring them on a day to day basis.

There are solutions that companies can and sometimes should be looking at in order to try and capture some upside.

And yeah, we definitely talk about that with our clients and a lot of times it just comes down to we get some clients where they are completely risk averse and we just, you know, for those we just want to do that one to one hedge.

We don't want to take any price risk and then we have others who are willing to pay a premium or do want a little bit of price exposure and we'll work with them to come up with some creative solutions.

You are instrumental in setting up the derivatives desk at gmi.

What was that like?

Did you have any kind of backlash from the physical players at the company?

What was your experience on their risk.

Profiles coming from the trading side?

That desk set up is usually something that just happens in the background.

You're not, you're not worried about imvm, you're not necessarily too concerned.

You just want to be able to trade the way you want to.

Working with physical traders, telling them, okay, we need to be careful about this position or that position because prices have gone one way, the other.

We're being margin called every day.

That can certainly be a challenge.

But I think the more you can loop everyone into that process, the more you can explain to them how things are working.

Even looking at the finance department, having them involved in these decisions, in the forward look of our positions so that they can better monitor the risk for margining I think is key.

But again, I mean it was new challenge to me opening up broker lines and you know, making sure that we had the capacity to hedge our physical and at the same time take the speculative positions that we needed.

Yet that, that wasn't something I was familiar with coming from the physical trading side at Traffic Europe.

But it was really interesting and I think being able to set up the desk and see that kind of back end of it definitely enhanced my own trading.

Were there any big speculative positions that you took that particularly paid off or.

Touchword didn't like a lot of people coming out of COVID that was a, a very rapid fall and in a fairly kind of consistent gain in the markets.

Not just commodities, but equities as well.

Coming out of COVID you know, and much, much like a lot of other people, I would say that I was probably caught going into Covid, not expecting it to be as drastic as a shift down as it was.

But then those kind of, those two years coming out of COVID we saw some pretty good positions work in our favor.

But for me, derivative trading is a lot more about risk management position Management sizing risk reward ratios than you know than physical trading is.

You try to be emotionless about derivative trading.

I think the best derivative traders are able to not pay attention to their losses, but equally not get too excited about their wins.

It's having a strategy, finding your edge and then repeating it for as long as it's working and trying to remain emotionless about those trades.

Are there any other maybe lessons that you would take from that time period and how do they shape what you advise clients to do?

Now the main lesson for me was the money management, the risk allocation of the book.

Now obviously a lot of my clients now are more on the hedging side, so less on the speculative side.

But it has allowed me to talk to that to the companies that do want to take some speculative risk about how their approach to that works and the importance of those risk reward ratios.

I saw an interesting interview with Ken Griffin from Citadel and he said his best traders directionally are only right about 52 to 53% of the time.

So the best traders at the some of the biggest hedge funds in the world are only right just over half of the time.

When you are trying to speculate, it's so much more important to focus on making sure that when you have a winning trade, you allow it to, you know, you want to ride that wave when you're wrong, be wrong quickly.

And that's the kind of the same approach that the physical traders that are looking to take a little bit of speculative risk can take where you know, okay, if we get this wrong, be wrong very quickly and allow when we're right for that room to the upside to grow.

When you look at the market, do you notice that there's any like noticeable gap in terms of practical education so removing the more academic side.

And is that kind of where the inspiration behind Perfectly Hedged came from then?

Yeah, absolutely.

I mean there are a lot of books on hedging and risk in general, but I was yet to find one that really utilized practical examples.

You know, as part of kind of my career in trading, I'd often been tasked with teaching risk and hedging to middle and back office.

And I'd always wished there was a practical book that I could use and you know, really drill down into these examples that people could see in their own day to day work.

I didn't find one.

And yeah, that was absolutely inspiration to write Perfectly Hedged.

And you know, there's, the book is littered with examples of my own trading experience that people can directly apply to their own day to day work and.

You'Ve recently partnered with the lme.

Can you tell me a little bit more about that?

We are working with the LME to deliver educational courses and again, lean on my own trading experience, both physical and derivative, to speak to the specific examples of risk that companies are facing on a day to day basis and how you can use LME instruments to mitigate those risks to protect your margins.

In this very volatile environment that we've been in for the last two, three.

Four years, I have a feeling that most of our clients will be more familiar with cme, ice, SGX and LME can sometimes feel like a little bit of a black box.

Can you walk us through some of the more unique features of the LME and some of the words like Tom next carries?

Absolutely, yeah.

So the LME is unique to most exchanges for a couple of reasons.

One, it still utilizes open outcry for two of their four trading sessions a day.

So if you are trading on, you know, an official settlement, your orders are going to flow through into the ring, which is where the traders kind of shout, use hand signals.

You know, it's when people think of those trading movies, the LME is one of the few exchanges that still looks like that.

When it comes to the structure of the lme, they're also unique in terms of their prompt dates.

So where metals on the CME only have one prompt date a month, what that means is if you buy a copper contract for July, for example, that will settle on the last business day of July.

It doesn't matter when you trade it, it's always going to be sitting on that last business day of July.

The LME has a tradable settlement date every business day on a rolling three month date.

So any business day from today through to the next three months, you can trade to that date if you want to.

So what that then follows to is a whole aspect of trading on LME where people are trading very nearby prompt dates.

So you mentioned Tom next.

So Tom means that you have a derivative position that settles the following business day.

So it's not always tomorrow.

If you're on a Friday, Tom would be Monday.

And Tom next just means moving that position from the following business day to the one after.

You also have cash trading.

So cash trades settle in two business days time.

So one of the most common methods to price a physical contract on ELME is, is to use the cash settlement, which is the last offer price in the second of those open out price sessions on the lme.

A lot of companies have to Navigate not just the month over month spreads like you would have to on the cme, but also those very nearby spreads, those tom neck spreads, those cash spreads, moving those positions throughout their entire book so that they make sure that they're not just managing their outright price exposure, but their spread exposure as well.

Fantastic.

They like to make it difficult for us, don't they?

So I just want to end on.

Is there any accepted academic theory that you don't necessarily agree with?

Hedging, in my mind is, is essentially, I say hedging is hedging across the board, across commodities.

Obviously there's nuances between those individual commodities, but for the most part hedging is applicable in the same way across commodities.

So I don't think I've come across someone who's proposing a new or different type of hedging.

A lot of these concepts are not going to change.

They haven't changed for the last hundred years.

They won't change for the next hundred years.

Oftentimes it's more about how you execute or understanding the nuances of your specific commodity.

As we talked about, how liquid is the market, how correlated is the physical to the underlying exchange contract?

If you're utilizing the lme, how do you navigate those different prompt date structures?

If you have positions across exchanges, like we've seen on Copper for example recently, where that arbitrage between the CME and the LME blew up to, you know, $2,000 a ton, how do you navigate that?

I wouldn't say there's necessarily an academic approach I disagree with.

I think that hedging can be very company specific and sometimes different companies need different tools to navigate that price risk.

Overall, the main concepts of hedging are very similar.

And that's why, you know, when we were designing the book, when we were designing our online course, we can take these concepts and apply them across the board so that they are really valuable regardless of your position, regardless of the type of company that you work for.

All right, thank you very much, Sam.

To any of our listeners that want to hear more, they can pick up your book on Amazon on your website.

Thank you so much for joining us today.

Oh, it's a pleasure being here, Jessica.

And now I'm joined by Carlo Boffa, who's a news reporter at Politico, a central bank watcher, to be specific.

Hi Carlo.

Thank you very much for joining us.

Hi Davide, thank you very much for the invitation.

Always a pleasure.

So Carlo and I were colleagues in another life, in another place, so to say.

So I thought that it was very, very nice to have him to come here and actually talked about a topic that is also connected to what we usually talk about, that is central banking, monetary policy, to be specific.

So Carlo, maybe we can start, I was thinking like maybe you can give us an overview of what has been the overall monetary policy stance of the main central banks, at least for this first six months of the year.

In Europe we have seen the ECB that among the big central banks has been the most active.

The ECB has lowered rates at every meeting and it has arrived at a 2% what they see as more or less like a neutral rate, a rate that doesn't stimulate the economy nor it tries to stop it from overeating.

While the bank of England has taken a more cautious approach.

The bank has cut rates to 4, 25%.

So it's much higher than the ECB, but it's trying to cut once a quarter because inflationary pressure there are still higher than they are in the Eurozone.

If I don't know Davide, how much you, you follow truth for social.

But if you, if you're active on the platform, you would see that the certain Donald Trump has been, has been complaining very vocally about the Fed because of the three, the Fed is the only one that has not moved yet.

So they have cut rates last year from a maximum of 550 to 425.

But they, but since, since Donald Trump entered the White House, they, they're still to move.

Now of course like the, the, the conversation that is happening between President Trump and Jay Powell is one of the many conversations that Donald Trump is having at the moment.

So as we are recording this segment on Tuesday afternoon, we were finding like very, very difficult to just do a recap of what has happened over the past 24 hours and how the markets have reacted so far.

You know Carlos, since most of the commodities markets that are all priced in dollars, how do you think that the Fed future monetary policy stance is going to influence, you know, like the greenback and then in turn also like what kind of influence we're going to see on the prices of commodities or are the prices of commodities influence the monetary stance, the monetary policy stance of the Fed?

What do you think what happened in this six months has gone against all what lecturers and scholars have been teaching in economic courses.

So the dollar basically has been seen historically as a safe haven.

So whenever there was there was troubles in the world, there was war or something alike, everyone would go to dollar into other safe assets.

This time Is the opposite the dollar.

Actually, if you compare the dollar to a basket of like other main currencies, the dollar has lost about 10% this year.

And what is even stranger if you want, is that as we said before, the United States actually have a higher interest rate than for example Europe.

So usually when a country has a higher interest rate, money should flow in the country, but this has not been the case.

So what you hear from markets usually is that the reason for this is the erratic policy of the new administration.

Markets haven't yet to understand where Trump's trade policy will go, where the immigration policy will go, a foreign policy will go.

It's, you know, as we've been saying just now, every, every 24 hours there is a, a bunch of new announcements that you never know how long they, they will resist.

Not these announcements.

This is quite interesting because this has fueled the speculation of and, and more talks of de dollarization.

This seems to me, but also to people more expert than I am, as a bit premature.

So it doesn't look like the dollar is going to, is going to lose its status as dominant currency.

But definitely more and more countries and funds investors are looking into diversifying their portfolios away from the dollar.

Concerning instead the oil market and the price of commodities.

Well, the ECB for example has been saying that the oil price is going to watch carefully the oil price.

This morning there was a, there was an interview in the FT with Bank de France Villeroy de Galot that is one of the most influential voices in the Governing Council.

And he was saying that basically yes, the oil price is going to be a main factor in their decision in the next, in the next few months.

But of course, you know, the oil price alone for central bank is important, but not the cause for rising or cutting rates.

As he mentioned today, for example, you will need to see what impact it will have with inflation on inflation expectations, what impact it will have on underlying inflation, for example.

And at the moment what is in at least in the Eurozone is still not visible that impact.

Carlo, and let me ask another question.

Now you've discussed about, well, you mentioned about the oil prices that they all contribute to create the opinions of like what's the future monetary policy stands and from you're a central bank watcher, so what can, what do you think that we can expect at least for the summer and let's say like the beginning of the fall, like it seems.

Do you think that there is going to be a continuous divergence between the stances of the central banks?

Or are we going to get again into a situation where the kind of like policy moves are going to be somehow coordinated.

What the book is telling us about.

It, everything will depend on the final amount of tariffs that will be imposed.

So whatever the tariff rate will be the size for what the central banks will do.

Let's say the three are in three slightly different positions at the moment because the ECB seems that it's almost done with the rate cuts.

Most of its policymakers are saying that, yeah, maybe we're going to cut again, but looks like there will be one, maybe two more cuts, not more than that.

Unless there will be like war escalations or, or other other external factors that will impact their decisions.

The bank of England rate path looks similar to the ECB in the sense that they will cut.

At least markets are pricing two more rate cuts.

Right.

But what's different is that markets are seeing more cuts in 2026.

So the travel to towards the trip of the bank of England towards the terminal rate is still not over and will continue in 2026.

Probably the most difficult to predict will be the Fed.

So at the Fed, you have, for example, very influential voices like Governor Chris Waller, who just on Friday said that it's time to start considering rate cuts.

Mr.

Trump will be very happy to hear that.

Yes, of course, of course.

That's what all of it is waiting for.

But it looks like Jay Powell, the chair of the Federal Open Market Committee, is not ready yet.

Today in the House of Representatives, just minutes before we started a conversation, he said that the Fed is still in a good position that can afford to wait a bit longer.

And of course, what power has been saying is that the ultimate tariff rate will be the decisive factor.

He also said that he doesn't know any forecaster that does not forecast that inflation is going to rise in the US in the next six months.

So since they see inflation going up, some say to 3%, it's difficult to see how they could meaningfully cut rates.

Carlo, then we probably need to have another conversation on these topics.

So whenever you want to come again to the podcast, you are always welcomed.

Thank you very much for joining us.

Definitely.

Thank you very much, Davide, for having me today.

Next up, we have Archie Smith, pure oil broker.

Hello.

Hello.

Good to have you.

I think this is a very much needed segment on today's podcast, considering the last couple of weeks for sure.

So we've seen some pretty dramatic swings in the crude oil market.

Why don't you talk us through that?

Yeah, we have particularly the last Few days it's been going a bit crazy.

Obviously there's been a lot of sort of macro headlines that are moving markets.

So initially we had a pretty aggressive open up to 81 plus on the front month crude contract.

That was following the weekend US strikes on Iranian nuclear facilities.

I've got to say, I mean myself and others in the market thought it would be more aggressive on the open.

I mean considering we finished trading on Friday around 76, I was thinking it would be a bit punchier.

Yeah.

But it's sort of literally Monday morning open peaked 81 plus and then called off for the rest of the day.

And I was a bit like, what's going on here?

Yeah, but I guess you could argue a lot of the geopolitical risk was already priced in and there was no actual oil, oil infrastructure targeted in any of the attacks.

Purely nuclear facilities, that was one thing.

And then the market sort of cooled off to like $78 per barrel for the rest of Monday because a lot of people, I mean a lot of people are asking the questions like, you know, what's going to happen, what's going to happen?

I think the market was very much waiting for Iranian response and retaliation and then basis that make moves.

If Iran were going to start hitting oil infrastructure, then yeah, we could have seen more of a spike, but it wasn't expected.

Another thing to consider as well is obviously the Iranian parliament agreed to shut the Strait of Hormuz again.

I was like, okay, we'll see a massive spike here.

Didn't really come into fruition.

And I think it's just because although parliament agreed it, I think the actual sort of logistics and practicality of it actually happening seemed very low at the time.

Iran trade a lot of oil with China and India and I would imagine behind the scenes there was some pressures from those sort of trading relationships to be like, look, please don't do this because this is going to be a serious spanner in the works.

Which it would have been if it actually happened then.

Yeah, we could have seen, we could.

Have had a, like the topping of the economy.

Yeah, yeah, a bit of a disaster.

It would have been a bit of a disaster.

The fact that it's still not happened, it looks unlikely.

And then we came crashing down sort of Monday night into Tuesday morning.

There was the strike, the Iranian retaliation happened.

It was strikes on US bases in Doha or around Qatar.

And again, I got it wrong.

I think, okay, surely we'll go up crude wise, it dropped off the face of a cliff down to sort of sub 70.

And after sort of reading further, when I got in Tuesday morning and getting a feel for what happened, it seemed it was very sort of a save face retaliation.

Right.

It was, I don't say organized, but Iran had sort of said, look, we're going to bomb these sites.

Everyone got out.

There was zero casualties.

I'm unsure if any missiles actually landed, although they were targeting US Military bases.

It was just seemed like a bit of a retaliation for the sake of a retaliation.

Yeah, I think Trump actually thanked Iran for the response.

I think he did.

Yeah, I think he did.

I think people would have been expecting something a bit more aggressive, bit more damaging.

We just saw crude really, really come off.

So now we're trading around sort of 67, $68 per bar, down from obviously the peak of 81 plus.

It's been pretty aggressive swings.

So considering that movement, how has your markets been reacting?

Yeah, I mean fuel has been, has been pretty aggressive movements as well, particularly the sing spreads.

I mean the 380, if I take the front July Wilkie 380 spread, I mean that was trading like $16 premium last week and then it traded $2 premium yesterday.

I mean we've been struggling to find buyers in the market of 380 spreads and Sing.5 spreads as well.

Sing.5 spreads have not come off as aggressively, but they've certainly, you know, there's not been too many buyers, particularly this, this week of trading.

And it's just because all of the Brent spreads are getting hammered.

So it's really hard to sort of gauge where fuel spreads are and obviously the sort of front end flat price which a lot of our chipping hedging guys use.

That's been, I mean that's having like $40 swings intraday because it's so tied to the price of Brent as well as the price of fuel cracks.

And fuel cracks have been moving a lot basis Brent.

They normally have an inverse relationship.

Yeah.

So yeah, it's been, it's just been a crazy few days, to be honest.

Yeah, I can imagine.

Yeah, been busy.

All right, well, thank you very much, Archie.

Thank you very much.

And that's it for this week.

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