By A Saj Mathews

Till 1960’s, natural rubber remained a commodity, a raw material in the hands of brokers responsible for bringing together sellers and buyers, and traders providing the logistics required to transport rubber between producers and consumers. Trading primarily took place on markets in consumption zones namely, London, New York, Hamburg and Tokyo.
The situation changed after 1960 when new marketplaces sprang up nearer the production zones, especially Kuala Lumpur in Malaysia. For both technical and financial reasons, large manufacturers sought to move closer to the producers, dealing directly with them through quality contracts. International Natural Rubber Organisation (INRO) was established in 1980 to operate the International Natural Rubber Agreement, with the main purpose of stabilizing natural rubber prices by buying and selling from a buffer stock. The Kuala Lumpur- headquartered INRO’s terms of reference also cover measures to improve the status of natural rubber by encouraging research and other activities.

INRO managed to limit the decline in prices up to the 1997 crisis, but could not prevent the price surges in 1987-89 and 1994-95. Having failed to satisfy the stakeholders in the commodity chain, and following the withdrawal of the main producers, INRO disappeared in 1999. Of late, rubber e-commerce is developing, which will somewhat encourage producers and consumers to move closer together; but it will also lead to changes in trading: Repositioning of traders, the demise or even stronger hold of paper trading, the disappearance of brokers.
Price and quality

It should be remembered that the price is not only the resultant of the different factors of supply and demand, but also one of the decisive factors in influencing processor-user purchasing policies. A worthwhile price for all the stakeholders in the commodity chain is the only guarantee of commodity chain stability. It must therefore remunerate the work of the producer, but also that of the processor carrying out primary processing. Too low a price may have direct repercussions for product quality. In some cases, the manufacturing industry has to bolster prices so as not to cause a slump in production that would be detrimental in the long term.

Prior to 1965, only visual criteria were applied when selecting smoked sheet, RSS or air-dried sheets (ADS) – based on recommendations in the Green Book: Cleanness, water content and appearance, leading to a classification obliging manufacturers to adapt to the batches received. After 1965, Technically Specified Rubber (TSR) came on the scene, for which physico-chemical criteria were provided indicating more the level of contamination than rubber processing properties (ISO 2000 standards). Consumers then had a large variety of grades and presentations to choose from for natural rubber: Sheets and crepes, along with a wide range of TSR rubbers from factories using different processes depending on the rubber growing tradition in the country in question.

With automation of the processes used, industry is seeking rubbers that are constant from one batch to the next, as can be obtained with synthetic rubbers. It is therefore essential to produce natural rubbers with constant characteristics. Direct contacts are therefore being established between buyers and suppliers with the introduction of certification procedures in some cases. This has gradually led the commodity chain to comply with standardization, not only for product quality, but also for social and environmental aspects.
Futures trading and its impact

In a path-breaking development, futures trading hit the rubber trading scenario in 2003 in India. “Speculators took the upper hand with the money power at their command and ultimately futures trading got into their clutches. Futures prices started influencing the daily market rates. Many tyre companies partly switched on to futures trading and procured supplies,” says N Radhakrishnan, Adviser to the Cochin Rubber Merchants Association in India
He is of the opinion that none of the declared benefits of futures trading accrued to rubber farmers. But the tyre industry was happy with the advent of futures trading as they could influence the rubber market. The initial euphoria vanished as years went by and many traders who participated in futures ran into heavy losses.

Today, Tokyo Commodity Exchange (TOCOM) is Japan’s largest and one of Asia’s most prominent commodity futures exchanges including that of rubber. Apart from rubber, it operates electronic markets for precious metals, oil and soft commodities.

The Singapore Commodity Exchange (SICOM) is a key commodity exchange for the trading of two of the world’s most important commodities, coffee and rubber. The Exchange offers market participants, the trading of rubber futures contracts on its electronic platform, e-SICOM, a fully integrated clearing and settlement system.

What experts say

Commenting on the advent of futures trading, Pradeep Mishra, Head-Research, Indian Commodity Exchange Limited, says “As a major consumer of the rubber, Japan sensed the need to provide effective market-based instruments to its user industry and hence commenced futures trading in rubber way back in 1952 on TOCOM. At present, major futures market for rubber are in Japan (TOCOM), China (SHFE), Singapore (SICOM) and India (ICEX).
According to him, over the last eight years, the price of rubber has remained in a bearish phase with significant volatility. As producers, farmers are the most exposed to the bearish price cycle they have felt the necessity of price hedging. Rightly so, it is the farmers and value chains upward from there are active in ICEX for trade and price risk management. Farmer’s cooperatives and rubber dealers/traders are actively trading and delivering on the exchange platform.

The Singapore Exchange (SGX) will be shortly launching a new rubber futures options contract for the rubber industry and the commodity market at large for traders, consumers and processors to trade and hedge their physical rubber. This new derivatives tool can be a complex instrument. His article is to give the reader a good basic understanding of the fundamentals of Options trading and its benefits for Rubber Producers, Consumers and Traders, says Patrick Yeo Ek Meng, Director of Global Commodities Sales, Straits Financial Group, Singapore.

According to him, an options contract is similar to buying an insurance policy. It gives the buyer the right to own the underlying asset or futures contract when he/she exercises it. The buyer of an option has the right to buy or to sell the underlying asset depending on his view of the market. Because of this right, he is required to pay an amount to the seller and this amount is known as the Premium.

By definition, an Option is a contractual agreement contingently (upon) to buy or sell a particular asset or a futures contract for a specified price within a specified time period. Buyers of Options, although has limited risks from the premium paid, there is one major disadvantage and that is the decay of the premium over time. The premium diminishes in value as it go closer to expiration and converged to zero value upon expiration. As options are wasting assets due to the lost in value over time. It is important to understand the rate of decay over time.

Trading fundamentals

Achieving cost efficient procurement or revenue maximizing marketing is a core strategic objective of buyers and sellers. Assessing the outlook for the supply and demand of natural rubber provides an initial view of the market’s balance, inferring forecasts for prices and trade flows, which can subsequently guide the future pricing of manufactured products or production planning.

In addition, buyers and sellers can generate additional value by understanding the spot and term price discovery process and structuring a trading portfolio that optimizes price, volumetric optionality and exposure to market, liquidity and counterparties’ risks. Buyers and sellers need to structure their portfolios to achieve optimal risk adjusted returns. This includes managing security of supply through long term contracts, participating in the price discovery process through a mix of spot and term contracts, and managing price risk through rolling exchange term contracts for hedging.
Buyers and sellers have a significant opportunity to enhance their commercial strategies for procurement or marketing by actively managing their portfolio mix and contractual structures to benefit from price dynamics and relative spreads across different exchanges. However, not all exchange contracts are equivalent.
(Inputs courtesy: www.researchgatenet, www.accenture.com, Patrick Yeo, Straits Financial Group, Pradeep Mishra, ICEX, N Radhakrishnan, Cochin Rubber merchants Association).