Nickel rotates, VW profits

ECB slowly becoming nervous
Inflation in the Eurozone (and the USA) does not appear to be just a temporary phenomenon. The ultra-loose monetary policy, lasting now for more than a decade which has set the base for demonetisation cannot be eliminated overnight. And combating it through hesitant interest rate hikes is not really conducive to have a quick impact either. In addition, a very diverse economic area in the Eurozone makes countermeasures difficult. For where higher interest rates may be too much of a burden on one country, the interest rate steps for other countries are far too slow. Of course, central banks will continue to deny any responsibility for inflation, but this is not happening all over Europe, as a look towards Switzerland shows.

Doing nothing brings blessings
The Swiss are showing signs of a stronger increase in inflation for the first time. At 2.9%, however, it is still far from the 7.9% in Europe. This is not due to the key interest rate of the Swiss National Bank (SNB), as this is also below zero, more precisely at minus 0.75%. However, the SNB has managed to steer clear of such interventions as the flooding of money through bond-buying programmes to finance the debts of, for example, the peripheral countries Italy and Portugal. As a result, the Swiss franc is still granted the function of a reserve currency, or safe haven, by investors.

Inevitably, this has put almost constant upward pressure on the franc, especially in times of crisis. However, in order not to slow down its own exports too much, the SNB has, therefore, regularly intervened in the foreign exchange market in recent years and weakened the currency by selling Swiss francs. Now it is therefore in the comfortable position of only having to do what most people do best, namely nothing. This alone already makes the currency appreciate and slows down part of the externally oriented economy.

On the other hand, a strong Swiss franc makes products imported from abroad cheaper, which further dampens price development. In this respect, it is clear that a more homogeneous economic area is better suited for a uniform monetary policy than a political entity such as the EU and Eurozone. Even though the euro is also reasonably solid, it is not a safe haven like the franc. Therefore, doing nothing here in Germany is not enough. But not all options have been used up yet either in the Eurozone, if indeed the blathering were to finally stop and bold action could be taken to raise interest rates. This will certainly be painful for some countries, but they have been living at the expense of the future for years. Logically, this must now be corrected. Everything has a price.

Current addendum: the Swiss central bank SNB surprisingly raised the key interest rate by a significant 0.5% on 16.06.2022. This shows that it takes its mandate in regard to monetary stability more seriously than the ECB. The increase is timely, and further rises have also been promised.

Interest rates rise faster and higher
Pressure for significant interest rate hikes will continue to increase in the coming days and weeks, for even in the USA, hopes that the inflation trend has already peaked have been shattered. Yields on 10-year US government bonds are already at 3.25% and shorter maturities are also rising. This is also causing share prices to fall and worrying times in the real estate markets. Nevertheless, an unpleasant, but at the same time, an orderly correction in the markets is more probable than a bubble bursting.

This is because inflation is currently also being driven, by a non too small extent, by free riders who are taking advantage of rising prices by not only passing on higher purchase costs but above all opportunistically increasing their own profit margins. It is reported, for example, that leasing banks are not only raising interest rates on car financing, but are also reducing residual values at the same time. Somewhat surprising if it is known that the used car market is sold out and production can hardly keep up with existing demand.

But people are not stupid and will not continuously be taken for a ride, neither as voters nor as consumers. So such price increases will not prove sustainable and will be balanced out again by a subsequent drop in demand, with inflation rates falling accordingly. It would be important that, through the use of appropriate instruments, such as the aforementioned bold interest rate increases, inflation rates do fall significantly before they are cemented for a longer period of time by matching nominal wage increases and an upward spiral is set in motion.

Stainless steel market quiet in summer
In reference to stainless steel raw materials, a calming of the market can already be seen, which is, however, not only due to there being fewer new orders from commercial and private consumers, as just mentioned, but above all due to seasonal effects and the usual maintenance work on existing machinery. For example, chrome, nickel, molybdenum and iron are currently showing a weaker trend, but here too there are specialists who propagate a presumably rather temporary demand deficit combined with matching market power as the “new normal”.

However, if the operating principles of markets over a longer period of time are studied, it will inevitably be apparent that price drops are just as normal as price increases. And especially in the case of stainless steel scrap, the very price-elastic availability introduces another aspect that also inevitably leads to rising prices again after a bottoming out and an increase in demand for raw materials. And the more erratic that price reductions are put into practice, the more erratic the subsequent price increases will be. It is a continuous give and take between buyer and seller, because there are always two parties to a purchase agreement. This is the old and new normal. By the way, nickel is currently trading on the LME at prices slightly above USD 25,000.00/mt.

The state cannot outsource everything
There is a tendency in Germany, but also in other western nations, for the state to become more and more eager to transfer sovereign responsibilities to private companies. For example, tax consultants and auditors in Germany have had to report (cross-border) tax saving schemes to the tax authorities for some time. What sounds absurd has meanwhile also been adopted into EU legislation. But in this way, the advisor no longer acts for his client, but is rather a vicarious agent of the polity for monitoring compliance with the tax obligations of private and corporate taxpayers. A sometimes heavy burden for the relationship of trust between advisor and client.

This phenomenon is also very well known in the banking and financial industry. With respect to clients by means of relevant KYC (know-your-customer) procedures and by filtering payment transactions, financial institutions are supposed to ensure that everything is in order with regard to sanctions, which can sometimes also be contradictory between the EU, the USA and the UK, as well as money laundering and fraud, and to report subsequent suspicious cases. Here, too, sovereign responsibilities are assumed instead of being fulfilled by governmental investigative bodies. In addition, it seems that customers are to be encouraged by their banks, through appropriate pressure and considerations in the corresponding credit decision-making processes, to behave well in terms of ESG (environment, social and governance).

From the state’s (and perhaps also society’s) point of view, this is a good thing, because on the one hand, many more informants and investigators are also under obligation, through related laws and regulations, without this being associated with higher costs for the community. On the contrary, related costs can be saved on the sovereign side. However, it is usual that in a delegation, responsibility and accountability ultimately remain with the delegator. The situation is different in the constellations described here, however, where even slight negligence in the meantime leads to draconian sanctions for those to whom the sovereign tasks have been delegated (without their request or consent).

Now, there is absolutely no question that laws and rules with their respective parliamentary legitimacy were created to be abided to, otherwise a society and also an economy does not function. However, it is actually the function of state investigators, such as tax officials and auditors or even the police, to examine and clarify the relevant facts. It is, therefore, not surprising that there are now also discussions going on (usually behind the scenes) as to whether there is not now “over-compliance” in some areas, which has a negative effect on essential basis of trust and on the functioning and efficiency of monetary and economic systems.

However, German companies are themselves also world champions in outsourcing, vividly seen so far by their high cost efficiency, but also by the current problems in the supply chains. So it is not surprising that the state does not want to feel outranked and has adopted this “success model”. The German publicist and foreign policy expert Constanze Stelzenmüller is quoted, for example, in the English business magazine “Economist” as saying that “Germany has outsourced its security to the United States, its energy supply to Russia and its export-oriented growth to China!” Well then, good luck!

LME strives to regain confidence
The London Metal Exchange (LME) is continuing its efforts to regain the lost trust of market participants and stakeholders. Robin Martin, Head of Market Development at the LME, as guest, took part in a session at the Bureau of International Recycling (BIR) Convention in Barcelona at the end of May. He was able to explain at first hand the measures taken after the market distortions and point out the perspectives for the future. Communication and exchange are a very important and correct component to reconstruct the success of the LME before the chaos in the nickel contract. According to official reporting, trading volumes in the nickel contract initially collapsed and have so far roughly halved compared to transactions before the crisis.

Meanwhile, too little is heard about the investigations by the Bank of England and the Financial Conduct Authority as well as the independent investigation initiated by the LME itself. This is not good at all, because a successful solution is, above all, dependent on how much time is taken. Meanwhile, there are numerous complaints about the LME’s behaviour, including from the Managed Futures Association (MFA), an interest group of the hedge fund industry, representing at least 140 investment companies. Again and again, it is about the question of whether it was in order for the LME to not only suspend trading on Tuesday, 8 March 2022, but also had the right to cancel completed trades and transactions. There is also the question of whether the fact that the LME owns the clearing house LME Clear may have caused conflicts of interest.

Understandably, those parties are angered whose positions had a high book profit that eventually disappeared again due to the cancellations. It is no wonder, then, that two lawsuits have already been filed by investors. The US hedge fund Elliott Management, and also the UK trading house, Jane Street, are trying to claim the “lost” profits in court. It will have to be seen now whether the rulebook of the LME and the circumstances satisfies the decision of the Special Committee. In particular, it is about whether or not the situation at the time was a disorderly market.

As Reuters columnist Andy Home writes in his article, Jane Street is not, of course, concerned with the monetary value, but with sending a signal against the unreasonable behaviour of an exchange. Surely it is all a matter of principle? What is certain is that the lawyers who are now involved in formulating the lawsuits and carrying them out will not go away empty-handed.

Volkswagen gains from nickel distortion
In connection to the above context, it is certainly newsworthy that the Volkswagen Group was also affected by the events on the LME. In its quarterly report for the first quarter of 2022, the VW Group reported that – despite a significant drop in vehicle deliveries of 1.9 million compared to 2.4 million in the corresponding period of the previous year – it successfully increased its operating profit by EUR 3.5 billion to EUR 8.3 billion. This is astonishing with such a large decline in vehicle numbers. This is why CEO Herbert Diess is being celebrated by the capital markets for the good performance.

If this is looked at more closely than most analysts and journalists, it is striking that the solid quarterly result, as the report writes on page 1, includes “positive effects from derivatives outside hedge accounting in the amount of EUR 3.5 billion”. On page 19, it is even more detailed and informs in the small print that it was particularly about commodity hedging for nickel.

However, this needs to be explained: Volkswagen had a certain foresight in hedging nickel prices in order to protect itself against price increases in nickel with regard to the future demand for batteries for electric vehicles, which contain a considerable amount of nickel. Due to nickel prices having risen significantly in the first quarter due to the known market distortions, Volkswagen made a considerable book profit on the existing hedging positions. However, the subsequent impact on performance in the following quarters will be interesting, as nickel prices have since fallen again significantly.

The corresponding book profits will then have to be corrected again with an effect on earnings and will have an impact on the quarterly result. Then, at the latest, the capital market and the press will wake up again. Then, however, depending on the extent of the correction, criticism will not be spared. Depending on the price trend on the LME, Mr Diess could be in for quite a shock. He will probably already know that, otherwise he can read about it here.