Thoughts on Base Metal ETCs
By Ted Arnold (additional; reporting by John Kemp & Guy Isherwood)
IN THE LAST few weeks we have seen a number of companies suggesting, and promising, to launch Exchange Traded Funds (ETFs) backed by physical base metals such as copper. If these funds take off we could see London Metal Exchange prices soar on the back of a fresh source of investor demand. ETF Securities has become the first to launch the
world’s first physically-backed industrial metal Exchange Traded Commodities (ETCs). These new products will, for the first time, give investors access to industrial metals in, “an easy, secure and transparent way via a security traded on the London Stock Exchange,” according to the issuer. In copper (theoretically) if fully subscribed
proposed ETCs (from ETF Securities, JP Morgan and BlackRock) would take around 185,000 tonnes off the market. LME stocks stand at around 350,000 tonnes so this would be substantially more than 50% of total LME stocks. This could almost certainly be described as a ‘corner’ of the market and presumably disallowed by the LME under its specialist rules that are triggered when any market participant becomes the dominant long.
... views are very mixed about the impact of such funds on the price and supply of metal
This is just one of the many questions that have
to be fully answered by JP Morgan, BlackRock, ETF Securities and others as they progress with their ETFs. Physical ETCs are based on LME warrants and therefore subject to strict exchange guidelines for managing the effect of a dominant position. This means that investors in an ETF might
be forced to reduce their position because the ETC has become the dominant position holder. Theoretically, this is something that ETC investors and the managers of an ETC could not accept because it would leave them without control over their inventories and would mean the product wouldn’t be properly physically-backed. The LME rules are triggered-off when an LME member or client holds 50% or more of the warrants and/or cash today/cash positions in relation to LME stocks. For markets like copper, lead, or tin where stocks are tight to relatively tight the chances are much higher that an ETC product would attract enough investment to push it into the category of dominant long.
74 December 2010 Diarmuid O’Hegarty, the LME’s head of regulation
and compliance and deputy chief executive, noted in a Dow Jones interview some weeks ago that “Anyone with a (electronic transfer system) LMEsword account holding warrants is subject to the LME Lending Guidance rules.” He went on to stress that, “The LME monitors the market in real-time and publishes a large volume of data publicly to ensure an orderly and transparent market.”
Questions Would-Be Investors Should Ask So one of the questions would-be investors in
the physically-backed base metal ETCs should ask is just how accountable, or otherwise, an ETC management company would be to the LME for the size of its ETC holdings. It is beyond dispute that buying and controlling metal (either on or off warrant) is bound to have a price impact. The bigger the holding, the bigger the likely price impact. This was, in fact, admitted by Goldman Sachs,
which owns the warehousing company Metro which BlackRock intends to use to store its copper. Goldman’s said in a recent research note that a copper ETF of more than 50,000 tonnes, equating to some 13% of total LME stocks, would disrupt the market. “A physical ETF in copper might exacerbate
short-term volatility and perhaps bring forward our forecasted deficit and extremely tight, backwardated market,” the report said. In the long- term, the bank played down concerns about the impact of these products’ on supply, noting that any tightness would quickly generate incentives for investors to sell the metal back into the market. But views are very mixed about the impact of
such funds on the price and supply of metal. Some producers, particularly aluminium producers, consider them a new sales avenue while consumers are concerned that availability of metal will decrease and prices and premiums will rise if material is locked up in funds of this type. Bloomsbury Minerals Economics’ Copper Briefing
Service noted in its October Copper Briefing Service editorial that “The relevance of ETFs to price is still being debated. Clearly, they will tie up metal, and in this respect could be said to be similar to existing long positions in futures contracts. There are critical differences, however, that should exaggerate the price impact. While futures contracts imply physical
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