There is not much time left
After the unfortunately negative iconic events on the London Metal Exchange (LME) in March 2022, it has since become very quiet, too quiet in the opinion of quite a few observers and market participants. Whilst steps were taken ad hoc already in March, for example the introduction of a maximum daily range and the suspension of trade during the early morning trade in Asia, as well as internal and external investigations being initiated, concrete results have yet to be seen. Therefore, confidence in the LME nickel market did not initially return. Traded volumes only slowly recovered and in the peak did not even reach more than half of the volume traded before the collapse.
However, the mistake should not be made of linking the functionality of the market just to the traded contracts. With appropriate regulation, such as sufficiently low position limits per economic unit, and a look also at the history of the volumes of the LME nickel contract, it becomes clear that even with lower trading figures, orderly trading is and was possible. In such a small niche market higher volatilities must always be expected, but the experienced participants on the LME nickel market have been used to this.
It is rather that the volatilities on the nickel market before the crisis can be described as unusually low, at times with values clearly below 20%. Therefore, an increase in 2022 of values over 20% cannot really come as a surprise. Considerable price swings in all asset classes have to be expected in a year of huge geopolitical and economic challenges and great insecurity. If, however, volatilities during the year have moved above 40% and, at times, even above 60%, then this is remarkable and the talk can indeed be about market distortions.
After the calm follows the storm
After the long bout of stillness, all of a sudden, just before and after the year change, news started to come in thick and fast about the LME nickel market, even if this was only because some of the news senders wanted to attract more attention in a period when news was scarce. The start was made by a report from both the news portal Reuters and Bloomberg on 23rd December 2022, that a British judge had dismissed the lawsuit filed by the hedge fund AQR Capital Investment and other plaintiffs seeking the release of telephone and meeting protocols of the LME’s decision to cancel transactions of the 8th March 2022. The judge based his decision on the fact that there could possibly have been a certain amount of misconduct by the LME, but when taking all things into consideration, the prospects of a successful lawsuit were negligible.
A good piece of news for the LME, as this result could also set a certain trend for future prominent lawsuits. The hedge funds themselves should have been left in no doubt that, apart from their own stakeholders, they will not find many other supporters for the argument, should the LME be found to have acted legally compliant of course, as this would ultimately put the speculative profit of individual investors above the reputation and functioning of London as a banking and stock exchange centre and question the preservation of an entire industrial value chain.
On the 5th January 2023, the LME then announced that its chair, Gay Huey Evans would step down this year and that the Board of Directors has already started looking for a replacement. According to the LME, the appointments of Martin Fraenkel, former President of S&P Global Platts and Pierre Vareille, former CEO of the aluminium manufacturer Constellium, to the Board of Directors are just now subject to regulatory confirmation.
Competition stimulates business
One day earlier, which was the 4th January 2023, quite a big sensation had already occurred. Global Commodities Holdings (GCH), based in London, made public its intention to start an electronic marketplace in the first quarter of 2023 for physical nickel trading. This news was combined with the suggestion that the price determination to be used on the platform to calculate an index could then be taken as a base for a future on a futures market in competition to the LME nickel contract. GCH is backed by large, listed mining groups such as Glencore, Anglo American, BHP Group and Rio Tinto. GHC already operates a trading platform for thermal and metallurgical coal called globalCOAL. Its index is already the subject of a future on the Intercontinental Exchange (ICE).
It is intriguing, that Martin Abbott, CEO of GCH and globalCOAL, has already been CEO of the LME. This does, however, say little about the chances of this venture being successful. At the moment quite a few reputable and some not very reputable institutions and platforms are trying to profit from the weakness of the LME. It does not, however, seem clear to all these contenders that alternative solutions are also confronted by the same challenges which face the LME. There are also considerable antitrust hurdles to overcome in regard to the calculation and publishing of price indices. And it can be difficult to build up confidence in an independent price calculation if the corresponding platform is operated and owned by a major commodity producer.
It is also difficult to compare, for example, the coal market with the nickel market in both size and importance. Therefore it is hard to comprehend how a new platform can also be able to be a reference for a future or other nickel product, if, as announced, only Class 1 nickel should be traded on this platform as it is at the moment on the LME. In the end, it is always the same game, if a price goes up, then the price is wrong and “manipulated” according to the buyers, and if the price goes down, then the price is wrong and “manipulated” according to the sellers. But if the goal is to improve how the nickel price is determined, then opportunistic statements or emotions do not help, only facts, discussions and action are useful.
External audit report can only be the beginning
In this respect, it was more than overdue that on the 10th January 2023 the LME, as a further “highlight”, published the long awaited review report of the commissioned consultant company Oliver Wyman and also included the first response of the Exchange. The 44 page report can be downloaded at https://www.lme.com/Trading/Initiatives/Nickel-market-independent-review. The object of the independent analysis was to identify the factors which had led to the events of the beginning of March 2022, and to also put forward suggestions for steps to be taken so that the LME can minimise the probability of similar events occurring again in the future. All details and the corresponding response of the LME can be read in the original documents, so here is just a summary of some of the main points.
It is apparent that processes, powers and transparency of the LME were not enough to prevent the events. Parallel to this however, the supervisory bodies and regulators are still examining the possibility of mistakes made by the Exchange and the clearing house, as well as the intermediaries and market participants involved. This could result in various approaches to be taken. Essentially, the causes are mainly the unsuitable and sometimes unknown size of the positions of individual market participants, both on the exchange and over-the-counter, and also the lack of liquidity.
The aim of the measures which have been suggested fall into three categories: the identification of risk to avoid extreme situations, the management and the control of extreme situations and the restoration of trust. And it is just this last point, clearly made by Oliver Wyman in the executive summary of the report, which is of very important significance. It is indispensable that trust returns for the market to get back on track again, for at the height of the chaotic fiasco the market lacked the decisive spectrum of market participants. Such ones who would have been prepared to enter into opposite transactions, or to state it more clearly, to sell nickel.
Yet for a long time now, the long-standing market observer has been forming the impression that it is exactly those physical market participants who have readily criticised the LME for its remoteness away from physical activities, and who have only used the LME sporadically. In order to regain the trust of old market participants and to win the trust of new ones, the rather more abstract recommendations of Oliver Wyman have to be put into practice by the LME and become operational. Only then can a potential client form an opinion of whether the Exchange can be trusted or not.
This is still a difficult piece of work, and there is no time to lose. And therefore, it is only consequential that the LME has announced that all steps will be taken to restore trust and confidence in the Exchange and it has pledged that it will draw up an implementation plan and this will be published by the end of the 1st quarter 2023. We wish the LME all the best of luck and success in this not very easy, but very necessary undertaking, as it has no alternative.
Supervisory authority prevents opening in Asia
On the 11th January 2023 reports continued with news which was less flattering for the LME. Reuters alleged to have learnt from three sources familiar with the matter that the Financial Conduct Authority (FCA), the supervisory body of the LME, had stopped the planned opening of the nickel market in the Asian morning hours. The FCA doubts whether in present times the LME can ensure sufficient control and monitoring of the market and volatility. This is not least because the crisis in March had actually started in Asia.
Finally, the Exchange in Asia opens trade via the electronic platform Select normally at 1 o’clock London time at night. On the 28th November 2022 already, Reuters had also reported that the LME had expressed the hope that trade in Asia would be opened again within the next 14 days. This was a prospect which had even given this author an uneasy feeling (see also the last report in this regard at https://www.oryx.com/en/casino-royal-or-casino-metal/). On the whole, this action is not really likely to help restore confidence in the mother of all commodity exchanges.
Unsurprisingly nickel remains volatile
In the meantime, since mid December, nickel prices on the LME have done justice to the much lamented yet always immanent volatility. At first the futures price made corrections to just over USD 27,000.00/mt, until a year-end rally started which took prices up to USD 31,975.00/mt on the 3rd of January 2023. After this prices turned down again, falling to just below USD 26,000.00/mt. At the moment nickel is trading around 27,500.00/mt.
Basically the uncertainty in the markets remains high due to the challenges which are well documented. The expected opening in China, which has now been implemented, gave an initial positive input which did, however, remain short term as the rapid increase in infections still had an influence on growth and economic activity. But the peak is expected already in January 2023 and with an increasing natural immunity in the population, the infection rate is expected to decrease for the future.
In this respect, there could be a significantly faster recovery in the Chinese economy, which is so important for raw material demand, and so could return to its old growth path more quickly. A recent poll by Reuters sees a rebound in 2023 for growth in China to 4.9%. This should in the medium term provide good support for commodity prices.
Is Opium part of the game?
The Chinese tycoon Xiang Guangda, with his words and actions, continues to keep the nickel market in suspense. For starters, at the beginning of 2021 he caused nickel prices to plummet by announcing that his company would deliver nickel matte from Indonesia to battery manufacturers. Then in March 2022 the well documented events on the LME nickel market followed, which were attributed to the “Big Shot” playing a decisive role. And now announcements by the nickel player are causing further unrest, as it is planned that his company is to change the production mix to more refined nickel.
Despite all the media attention, it is not clear how these announcements can actually bring the hoped advantage for the company group. It is more the case that prices have fallen each time, which is hardly advantageous for a manufacturer and seller of nickel products. Or that margin calls threatened the nickel producer with insolvency. In earlier times and dynasties it could have been thought that too much opium had been smoked. In the midst of economic conflicts, such as the trade wars between the USA and China, or the USA and Europe or China and Europe, it cannot, however, be ruled out that the actions are not of one individual character, but have to be seen in a larger context, without touching on any conspiracy theories here.
Nevertheless, what becomes very clear about this story is that it cannot be right that one individual person or company can have such an influence on markets and prices. Such influences are simply not healthy and have to be excluded through necessary regulation and monitoring. It does not help either to refer to the former esteemed US Federal Reserve Chairman Alan Greenspan who, it was said, only needed to cough to start the US dollar exchange rate and the stock markets moving.
US-Dollar has lost some strength
Nearly every asset class performed miserably in 2022. Only the US-dollar had a remarkable performance. Among other things, the brave intervention by the Fed in the face of dramatic inflation was honoured by the capital market. Whilst the US economy was indeed facing recession, American companies did, however, fare certainly better than the competitors in Europe and Japan. The outbreak of the war in the Ukraine and the dramatic increase in energy prices which followed significantly boosted the US-dollar against the Euro. Europe, once Russia’s most loyal energy customer, was hit by the energy price increases much harder than the USA. Japan had to struggle with a lower global demand for industrial goods, which normally make up the bulk of its exports. China’s zero-Covid policy and the real estate bubble continued to fuel demand for the greenback. This enabled the US-dollar last year to reach its highest level in real terms since 1985.
Now the tide seems to be turning. The US-dollar, in the past weeks, dramatically lost in strength. The slower pace of interest rate increase, the recovery of the European economy and the end of the zero-Covid policy in China brought about a fall in the US-dollar rate. If in the near future there is an unexpected easing in the Ukraine war, then the US-dollar can lose even more strength.
Fed could raise interest rates too much
According to the former Fed President Richard Fisher, the Fed is embarrassed about its former assessment that inflation is just temporary and will probably raise interest rates too much. Central bankers have indicated that they will increase rates to over 5%, whereby a 25 to 50 basis points increase is possible in February. The former Fed President warned that perhaps stock prices have not priced in the high interest rates which could lead to downward pressure. He also has fears that since the Fed does not really want to stop raising interest rates too soon, so making a second mistake, then it will overshoot the target. Raising the key interest rate too high could put a stranglehold on the economy and lead to a recession.
LME (London Metal Exchange)
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