Inside the Broker - LME suspends nickel trading

Inside the Broker

LME suspends nickel trading

Like many commodities, the price of nickel rose steadily last year. It gained around 25% in 2021 to hit $20,800 per metric ton at the beginning of 2022. But in the space of two days last week, it effectively doubled twice, briefly hitting $100,000 (a gain of 300% since the start of the year) before the London Metals Exchange (LME) suspended trading. The LME then took the unusual step of breaking, or cancelling, trades done after midnight on 8th March. Bloomberg estimates that these cancelled trades have a value of around $3.9 billion.  It was hoped that trading would resume on Friday 11th March. But the market remained closed as the LME said that it was still working on ‘appropriate operational procedures to effect a safe reopening’ and on netting off long and short positions. Concerning the latter, the exchange said that there was a ‘limited potential uptake, particularly from those with short positions, and considerable differences in view on the appropriate price.’ So, the work goes on, although the LME have announced that trading should resume at 08:00 GMT on Wednesday 16th March.

Drastic and controversial

Suspending a market and cancelling trades are drastic moves for an exchange to make. The LME insists these measures were taken to ensure the integrity of the market, at least for producers and consumers of the commodity itself. But it is a concern that the interested parties took over a week to find a workable compromise to restart trading. It is perhaps more of a concern that other market users have been ignored. Traders and speculators who add vital liquidity to help the market function are preparing legal action against the LME. This could be a serious problem for the exchange, perhaps more so than the collapse of tin trading back in the 1980s.

Vital commodity

Nickel is a vital ingredient in the manufacture of stainless steel and in the batteries of electric vehicles. The former is cyclical, and demand has been rising since the end of the coronavirus pandemic. The latter is currently in a strong upward trend as demand for electric vehicles increases. So, there have been supply bottlenecks, thanks to coronavirus. On top of this, we now have the loss of Russian production, which provided around 11% of global supply. Not only this, but one Russian company, MMC Norilsk Nickel PJSC supplied 17% of the Class 1 nickel needed for EV batteries.

 

 

Selling short

Commodity markets are different from stock markets in that short selling is generally carried out for normal prudent business reasons. Producers will sell futures against expected production to lock in profits. So, there’s relatively less shorting for speculative reasons when compared to the stock market for example. But when you sell short, you must put up margin with the exchange, and prices are marked to market each day. If you are short and prices rise, you must come up with additional margin each day to cover your paper losses, even although you can reasonably expect your physical inventory to be worth more as well. The difference is that you haven’t realised a profit on your physical until it is sold and delivered. Margin requirements must be paid immediately or your futures position faces liquidation, at whatever price pertains in the market. So, there’s a mismatch. If you’re caught in this situation, and forced to buy back your short hedges, then prices will rise. This will affect other short sellers leading to more buying and prices rise further. This can turn into a short squeeze where prices suddenly skyrocket with forced buyers outnumbering sellers. In this situation the exchange price of the metal gets knocked out of kilter with the price of the ‘physical’ metal, which is usually a function of supply and demand. This is a big problem for producers and users of nickel, but less so for speculators and traders.

Hedging activity

Chinese tycoon, Xiang Guangda, is chairman and founder of China’s Tsingshan Holding Group Co, the world’s largest nickel and stainless-steel producer. It was understood that the company had a large short position, estimated to be over 150,000 metric tons. Recently the company had trouble meeting margin calls, and this has been a major contribution to the rise in nickel prices. Other companies are affected as well, including JPMorgan, BNP Paribas and Standard Chartered banks, and brokerages, with some of the latter close to failure. This would have had devastating consequences for the metals market and so the LME and the counterparties that use the exchange have worked hard to unravel the situation and maintain market integrity. On Monday evening, March 14th, the LME announced that bank support for Tsingshan Group “could suggest that the potential for further disorderly conditions may be mitigated.” Hence the plan to restart trading on Wednesday morning.

Limits – at last

The LME has said it will now install daily price limits across metals. For nickel, there will be a 5% price limit in either direction. This would halt the market temporarily. All other metals are now subject to a 15% limit in either direction. The LME has also said that it will review the trading activity and the market conditions that led to last week’s events. But this may not be enough for some market users whose faith in the LME has once again taken a knock. The exchange will have to undertake considerable improvements to restore its credibility.