MAC: Mines and Communities

London put on its metal, flagrant manipulation exposed

Published by MAC on 2012-05-29
Source: Statement, Reuters, Business News Americas (2012-05-24)

What is the London Metal Exchange - and who dominates its trading?

The London Metal Exchange (LME) is currently in the news. Like London's fledgling - and virtually failed - PLUS stock exchange, it's "up for sale". See: Should PLUS Go MINUS?

Whoever buys the LME will likely not seek to substantially change its modus operandi.

And, as with PLUS, existing shareholders must agree to any sale.

The LME is unique in operating an "Open Cry" system, which is literally that: traders, agents, sellers and buyers of metal stocks shout numbers at each other across a crowded oval room.

Purportedly this makes LME's trades "transparent" in determining futures and options contracts for many of the world's most prized nonferrous metals (aluminium, copper, tin, nickel, zinc, lead, aluminium alloy, steel billet, cobalt and molybdenum).

It also operates a 24-hour "inter-office market" and an electronic trading platform

There are five categories of LME membership.

The most significant and powerful (category 1) consists primarily of investment banks - including Barclays, JP Morgan [see story below] and Societe Generale. Known as members of the open-cry "Ring", they have full trading privileges.

Category 2 - Associated broker clearing members - include other banks, like Credit Suisse, Goldman Sachs, HSBC, Merrill Lynch, Morgan Stanley and Standard Bank plc. They have all the privileges of category 1 ring dealing members, except may not openly trade in the Ring, operating instead through the 24 hour inter-office market, or the clearing house.

Category 3, Associate broker members, may issue LME contracts, but aren't members of the clearing house, nor may they trade in the Ring. They operate through the 24 hour inter-office market, and among this membership is the Royal Bank of Scotland.

The lowest, Category 5, members are primarily mining companies, including BHP Billiton, Rio Tinto, Rio Tinto-Alcan, Glencore, Freeport, Outokompu and Vale. Purportedly they are allowed to act only as "clients".

It's commonly believed that LME warehousing of physical metals is what keeps its trading system sound.

Possession of these verified stocks aids in maintaining a balance between supply and demand. So, to protect the interests of producers and consumers from sudden rises or fall in prices, the LME itself may release some of these supplies into the market.

In reality, only a small proportion of warehouse stocks are used for this purpose. Known as "a market of last resort", the mechanism is triggered in a relatively small number of instances.

Otherwise, most of what is held in the LME warehouses are employed for hedging purposes - to underpin futures and options contracts.

Just last week, however, the manner in which one LME Category 5 client, Glencore, is exploiting LME warehousing for its own ends, came under scrutiny.

Moreover JP Morgan - one of the LME Category 1 banks - has also been accused of threatening the stability on which the Exchange is predicated.

Taking stock

Glencore is not only one of the world's top mining companies, but its premier metals trader.

The London-based firm is now accused of "tightening its grip on the global zinc market by moving material to inaccessible locations, forcing industrial users to pay high physical premiums for a metal that is in surplus" [see Reuters report below].

With a reported 60% of the world's zinc trade under its control, Glencore is allegedly using warehouses monitored by the London Metal Exchange "to stow away the metal and support [its own] premiums".

Disturbingly, what Glencore is doing isn't illegal under LME rules.

For its part, JP Morgan (by far the most significant commercial bank involved in hranting mining finance) has proposed launching an Exchange Traded Fund (ETF) based on the acquisition of huge amounts of copper.

This poses the alarming prospect of a "removal of all or substantially all of the [copper] stocks in all of the LME warehouses in the US", according to a US law firm.

If permitted, the move could cause an immediate spike in the cash price for copper, with manufacturers and fabricators having to pass these increases on to their customers.

These, then, are two glaring examples of the way in which the London Metal Exchange is exposed  to manipulation by some of its own members.

It's surely high time to abandon any pretense that the LME is a transparent trading floor in metals, based on a real need for them by millions of potential consumers.

The LME is increasingly looking like a body being ruthlessly undermined by the naked greed of a few of its own bona fide members.

And it seems powerless to stop them doing so.

Glencore stockpiles zinc, tightens grip on global market

Reuters

16 May 2012

Commodity trader Glencore is tightening its grip on the global zinc market by moving material to inaccessible locations, forcing industrial users to pay high physical premiums for a metal that is in surplus.

The matter is under scrutiny because Glencore, which controls 60 per cent of the world's zinc trade, is using warehouses monitored by the London Metal Exchange (LME) to stow away the metal and support premiums, sources told Reuters.

The LME, the world's biggest metals marketplace, has come under strong criticism recently because metal sitting in some of the warehouses that it monitors is unavailable in practice, backlogged in some cases for up to a year.

The criticism has centered on the bottlenecks in aluminum, and the LME has introduced new rules recently aimed at combating the problem. But the matter of unavailable metal persists, and is arguably getting worse.

Glencore's tactics, however, do not contravene any market rules and are seen by many as legitimate business practice.

Latest LME data shows a sharp increase in zinc inventories in New Orleans, a dead-end destination for the galvanizing metal not because of backlogs, but because it is out of reach of industrial hubs, even in the United States.

In fact, more than 80 per cent of the 196,000 tonne increase in zinc stocks since late last year has been in New Orleans, with around 30,000 tonnes arriving in the last two weeks alone at the location that already holds two thirds of LME zinc stocks.

"Glencore has always controlled zinc in Europe. They don't want a surplus there, they want higher premiums, so they're shipping all the surplus from Asturiana de Zinc (in Spain) to New Orleans, where no one wants it," said a London-based source.

Glencore declined to comment.

LME data shows the Swiss-based commodity trader owns slightly less than half the warehouses in New Orleans through its Pacorini subsidiary. The warehousing business, thanks in part to the specifics of the LME system, is becoming very lucrative.

The LME is set up as a market of last resort, meaning there is always a buyer for every seller. In other words, when the zinc arrives in New Orleans, Glencore as the owner of the metal always has the option to sell it.

In market parlance, this is called putting zinc warrants or ownership titles ‘back in the clearing'.

The crux is that this type of selling, in zinc at least, leaves market balances tight and premiums high, as market players are loathe to pay to ship metal from New Orleans to a more convenient location.

Moreover, this kind of selling allows Glencore, as a warehouse owner, to collect lucrative rent from any counter-party to an LME trade that gets dumped with New Orleans zinc warrants.

"Glencore is moving zinc to New Orleans, putting it back on warrant and collecting rent. They're not trying to build a queue necessarily, they don't really need to as the metal is not going to get out of there," said another London-based source.

Long-term punt

Premiums - the amount paid over the LME cash price for physical metal - are currently at around $130-135 a tonne for zinc in Rotterdam. By contrast, premiums for copper, a metal in deficit which trades at four times the price of zinc, are only at around $70-80 a tonne.

Sources said that while Glencore has sold some of the zinc warrants in New Orleans, it is at the same time holding onto a fair portion of the others because of its long-term punt on rising zinc demand.

The punt is not outrageous. Miners have been betting that the zinc market will be in a deficit within five years as old mines run dry, resulting in massive investment in new zinc projects lately.

Should this view transpire, premiums for physical zinc would likely shoot up even further, with customers forced to pay extra even for zinc located in inaccessible places such as New Orleans.

Taking the view that it will be able to profit from a rise in zinc prices, Glencore agreed in February to buy zinc concentrates from Peruvian miner Volcan without even charging for processing the metal.

The risk, however, is that should demand recover strongly, premiums could shoot up, resulting in hundreds of thousands of tonnes of zinc held in warehouses suddenly flooding the market, stemming a price recovery or even spurring a crash.

"What will happen when financial markets return to a healthy state? What will happen to volumes in bonded in warehouses? Will they run into the physical markets? What will happen to the premiums then? It is a game that will end one day," said a Europe-based physical zinc trader.


Copper ETFs would create shortages, higher prices, volatility, law firm says

Business News Americas

24 May 2012

The launch of copper-backed ETFs, as is being proposed by investment companies such as JPMorgan Chase and BlackRock, would cause "enormous artificially created spikes in price" and would inevitably lead to shortages, higher prices for consumers and increased volatility, according to New York-based law firm Vandenberg & Feliu.

"Unlike, gold, silver, platinum and palladium, which traditionally have been held in storage for long term investment, copper is used exclusively for industrial purposes," the law firm said in a letter the US securities and exchange commission, on behalf of "a major copper merchant company and several copper fabricators" in the US.

Physically backed ETFs have been successfully launched for gold, silver and palladium, but the law firm argues that these precious metals are conceptually completely different.

"Because they are tradable as currencies, there are ample stored sources of gold, silver, platinum and palladium that can easily be acquired to back an ETF without any disruption in the market."

Copper, on the other hand, is not generally stored for long term investment purposes and therefore removing what is necessary to create ETF funds "could result in the removal of all or substantially all of the stocks in all of the LME warehouses in the US."

If approved, the JPMorgan ETF would acquire as much as 61,800t of copper from LME warehouses, which is equivalent to about 30% of global supply for immediate delivery.

The result would almost certainly be an immediate spike in the cash price for copper, as well as an immediate spike in the cash to three-month spread price of copper. "Manufacturers and fabricators will have to pass these increases in price on to their customers," the law firm said.

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