Deja Vu All Over Again?
Deja Vu All Over Again?
First published, November 18, 2005
Copper Report.
Déjà vu all over again?
The LME has the annoying and unforgivable habit of always being in the middle of metal
trading scandals, while its compliance department professes that all is under control and
that there are no problems. The latest “scandal” is apparently the short positions taken on
the LME in copper by a certain Liu Qibing who was, or maybe still is, a trader for National
Development and Reform Commission in China.
What is not clear: were those positions transacted in his employers’ name, and did the
employer authorize the positions, or were they taken in the name of another entity in
which Liu may have had an interest?
If the positions were sanctioned by the commission they would be the commission’s
responsibility. If the commission didn’t know about them, it has an argument not to honor
those trades. If the trades were in an entity not related to them, the commission would
walk. It remains to be seen who did what and where with whom. Trouble is, no one seems
to know, including the LME.
What is unique about the current squeeze is its timing. Usually, when a short or a long gets
into trouble, it takes the market by surprise, and there is a knee jerk reaction in the price.
In this instance, the market has been behaving unusually for months. It has been bid up
when weakness appears, much like the market action of Hamanaka or the tin buffer stock
manager.
It’s almost as if the aggressive buyers knew months in advance that Qibing would be in
trouble. But how could that be? Hedge funds and professional gamblers calculate the odds
on any bet. How could you predict the odds months ago that a Chinese entity would be in
trouble now? How would you know that the selling was a short position which had to be
covered? How would you know if it were authorized or not? How would you know that it
wasn’t against physical intake? How would you know the Chinese overall book? Why would
you assume that you could take on a government entity with access to billions of dollars as
well as copper? How would you know that?
So now we have, in opposing camps, the funds long as long can be, trying to force the
Chinese to cover their shorts. If they are successful some longs will be able to get out and
ring the cash register while extolling the virtues of a free market—while claiming that it’s a
concept the Chinese clearly have not grasped. The balance of the longs will be sitting with
positions as the market begins to crumble beneath them, and they will see the prices
collapse as those that get out hammer the price down, knowing that the short covering is
done. We could have the price literally collapse overnight, with the longs scrambling to sell
(to whom) and feverishly trying to come up with the margin money. Ironically the market
could face defaults at the top and at the bottom of the price range.
What if the Chinese do deliver? The most significant factor in driving the price of copper up
in the last few years has, ironically, been the physical buying from China. But not all that
copper has been consumed. Some, or maybe a lot, has gone into strategic reserves. What if
the deliveries are made‐ and they don’t necessarily have to be delivered by December 21st?
That would leave ALL the funds long and no shorts to squeeze, and a price collapse to
follow.
Unless a commodities market provides a reliable barometer for price discovery reflecting
current and future supply and demand, it has no particular function. Speculation is part of
the price discovery mechanism, and provides liquidity when consumers or producers are
inactive. However, price manipulation purely to drive out longs or shorts is not
speculation: gouging may be more descriptive.
The role of the LME is to provide the forum for price discovery. It has the responsibility to
ensure that there is an orderly market, free of manipulation. It has failed in that
responsibility on many occasions, and is in the midst of doing the same again. The
questions posed to the LME were:
A.Are the positions in the market authorized?
B.Are the entities credit worthy?
Recent statements out of China would indicate that the answer to A is no, which may
impact the commission’s willingness to perform on B. Had the LME asked these questions
when concerns were first expressed by market observers, we would not be in the current
state of chaos and uncertainty.
Markets have a habit of eventually correcting anomalies. If copper is currently priced
higher than its true value, it will eventually trade below its true value until equilibrium is
achieved. If the unwinding of this mess throws up the same problems encountered with
Sumitomo and the International Tin Council, we may not have an LME. As it is right now,
that may not be a bad thing.
David Threlkeld
Friday, April 25, 2008