GRAVITY SHIFT (TGITM Q4 2020)
In Gravity Shift, we saw how the spectacular growth of China’s economy and manufacturing industry has shifted the metals world eastwards over the past 25 years.
Back in the early 1990s, the global metals world was dominated by customers from the US, Europe and Japan, with the LME sat in the centre and approximately 95% of physical copper contracts referencing the LME Settlement price.
In the US, COMEX copper was largely used for domestic US hedging and LME arbitrage. Japan’s influence suffered in 1996, after rogue copper trader Hamanaka’s failed attempt to control LME copper prices.
China’s rise since the late 1990s has seen metal contract volumes soar on the Shanghai Futures Exchange, which now sets the mood on the LME open.
However, China’s growth in metals trading hasn’t always been smooth sailing. Liu Qibing was the government copper trader for China’s SRCSR, which traded on behalf of China’s Strategic Reserve Bureau (SRB), and he arbitraged successfully between LME and SHFE. However, in 2005 he incurred embarrassing losses trading vanilla and structured contracts against expectations that LME copper prices would remain in the $3k-$4k range. Speculative investors drove prices higher through $4k, triggering double short clauses which helped increase short positions believed to exceed the physical copper stockpile held at the SRB.
Many felt the fallout was badly handled, with some officials denying knowledge of Liu Qibing and stating that the SRB wasn’t the short seller. The relationship between the SRCSR, SRB and China’s National Development and Reform Commission was also rather opaque, with affected LME members pursuing the SRB for Liu Qibing’s losses.
Given the history, some were surprised when HKEx purchased the LME for . $2.15bn in 2012, which may have looked expensive basis the historical fee income.
Given that approximately half of all base metals are consumed in China, HKEx’s purchase of the LME perhaps offered them more control should another metals event occur? Metals financing has threatened problems for the LME market, although it’s a much larger issue for domestic Chinese lenders. In 2010, China’s government restricted bank lending to the booming property sector (TGITM, “Slow boat to China”), but property companies resorted to transit financing, gaining cheap “collateralized loans” in mainland China against expected commodity imports.
In 2014, there was a significant issue with missing aluminium collateral at Qingdao, but the authorities blocked access to the site, and western parties settled in London’s high court.
Despite other events, LME warehouse receipts and associated “Bills of Lading” continued to be used for financing into this year, when issues with missing financed nickel and bags of stones on LME warrant dented the market’s appetite for metals financing, and also delayed the 1am re- start of Ni trading on LME Select.
March 2022 saw a real crisis for the LME, after China’s biggest producer of stainless steel, nickel pig iron and ferro nickel shorted the LME Ni contract. The short position was many times larger than the available LME nickel stock, and the risk was compounded by the seller not producing anything remotely close to LME good delivery nickel.
LME 3m nickel prices moved up from $30k on Friday 4 March to $55k on Monday 7 March, and traded in a $10k range shortly before Monday’s Select close. LME Ni then exceeded $101k on Tuesday morning before the LME suspended trading at 8.15am London time over real concerns that unpaid margin calls would bankrupt the market.
The LME then took steps which were questioned in some quarters, including: • LME cancelled all LME Ni trades from 1am to 8.15am, that morning
• Closed the Ni market for over a week, re-opening 16 March
• Suspended the nearby backwardation (i.e. no penalty for being short) • Applied daily up/down price limits
On re-opening the market, the Ni price traded lower in thin volume, eventually returning to the price levels pre-closure by May. Given the size of the short position relative to the LME stocks, the short seller would have benefitted from the absence of a backwardation and the managed price fall lower.
There have been several lawsuits against the LME’s handling of the nickel market, and a resulting loss of trading volumes and confidence in the market, with the UK’s Financial Conduct Authority and Bank of England also looking at the LME and LME Clear.
Time will tell if the LME’s handling of this nickel crisis changed opinion on HKEx’s 2012 purchase?
THE CENTRE OF THE METALS TRADING WORLD HAS MOVED EASTWARDS OVER THE PAST 25 YEARS. WILL RECENT EVENTS IN THE NICKEL MARKET ALTER THAT SHIFT?
5 | ADMISI - The Ghost In The Machine | Q2 Edition 2023
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