Commodity Modeling and Pricing: Methods for Analyzing Resource Market Behavior

CHAPTER 6

Metal Prices and the Supply of Storage

Paul Crompton and Irene M. Xiarchos

INTRODUCTION

Inventory behavior provides a key to understanding price and equilibrium adjustment processes in international metals markets, yet it has received only minimal attention in the economic and econometric analyses of these markets. One reason for this has been the lack of suitable inventory or stock data. Another has been the lack of any uniform theory of inventory behavior or inventory-price relationship to serve as a basis for research. Among the diverse theories that have appeared, the supply of storage was one of the first. Attempts have been made to apply this theory to metal markets but with only mixed results. One problem with such studies has been the lack of useful inventory data. This chapter reexamines this theory by employing time-series tests based on now-existing stock data for aluminum, copper, lead, and zinc. We question the rigor of this theory and show that most of its explanatory power rests between stock, cash, and futures prices, not the basis. Employing unit root tests for preliminary integration analysis, we then test for cointegration among stocks, cash, and futures prices employing the Johansen test procedure. Confirmation of cointegration dictates that causality be tested using the corresponding Granger error correction model. Results of this analysis suggest that inventories drive prices rather than the reverse causality.

INVENTORY BEHAVIOR AND PRICES