Open Letter to the Chief Executive of the LME
Open Letter to the Chief Executive of the LME
July 1st 2008
Dear Mr. Abbott,
I am writing to you concerning the comments you made in an interview with Bloomberg on June 25th.
As the Chief Executive of the London Metal Exchange (LME), the worlds largest metals market, the opinions you publicly express are widely circulated and are very influential in decisions made in the industrial and financial sectors. I was somewhat surprised that during these unprecedented times of runaway commodity prices and accusations of market distortions that you did not use the interview as an opportunity to inform the world of what the LME was doing to insure orderly and honest trading.
As a user of the LME and a free market advocate I have a great deal of trouble agreeing with your arguments and justification for current prices, especially copper. I will address my concerns in the order Bloomberg published them.
-- Governments would be ``foolish'' to limit participation in commodity markets and curb speculation because prices are based on supply and demand, London Metal Exchange Chief Executive Officer Martin Abbott said. “
Politicians have threatened to introduce legislation to curb commodity speculation because they do not believe that prices are fundamentally justified and have not been reassured by the exchanges that this is in fact the case. In the absence of other explanations of why markets are doing what they are doing speculators and hedge funds have become an easy political target of where to lay blame.
Speculation does generate the necessary two-way volume for commodity markets and provided that the positions are realistically margined are conducive for a more liquid and stable market.
The buying of commodities as a long-term investment has not been on a scale that would disrupt prices for any protracted period of time. These transactions are generally supported by substantial cash allocations and are well secured.
Fundamentally prices of all commodities eventually are based on production and consumption with periods of gross distortion.
“Rising demand from emerging markets and a lack of investment by suppliers have created a ``structural change'' in commodity markets, fueling higher prices, Abbott said –“
In the current global economic slow down it would be fundamentally reasonable to assume that consumption has gone down and prices have weakened. This indeed is the case for lead, zinc and nickel. Copper on the other hand has remained stubbornly resilient and is in striking distance of its previous all time high despite the increasingly bearish fundamentals.
The International Copper Study Group (ICSG) reported a production shortfall for 2007 of about 55.000 tons, which is the basis of the widely published conclusion that copper remains “tight”. However, the ICSG also states that those numbers makes the assumption that all copper imported into China was consumed (Chinese consumption would have had to have been up 37%). To find out what was actually happening statistically in China one would look at the National Statistical Bureau (NSB) numbers to see what was produced plus what was imported and subtract what was consumed.
Consumption (3.990,000)
Production 3.441,000
Net Imports 1.350,000
________
Surplus Balance 801,000
In 2007 world refined copper production substantially exceeded consumption by at least 750,000 tons. The inventory overhang in China has caused its prices to be at substantial discount to the rest of the world.
In the first quarter of this year the International copper Study Group has reported that global consumption is down by nearly 1%
First quarter average mine capacity utilization was slashed to 81%.
This is a fundamental picture of slowing consumption, unreported copper inventories and producers reducing production in face or worsening consumption.
``There is no way that any speculator wants to be the person driving the market,'' said Abbott, who heads the 131- year-old LME. ``Anyone can think of a strategy that would drive a market, but not many people have managed to think of a strategy that would get them out of that strategy with a profit. That's one of the things that keeps markets safe.''
Speculators in metals have in the past attempted on numerous occasions to drive markets and in the end have invariably resorted to manipulative practices as to try and exit the position. Sumitomo, despite being very much on every ones radar, was able to operate a manipulative scheme for over 5 years without detection. It has happened before and there is absolutely no reason why it could not happen again.
``We didn't invest in plants, we didn't invest in deposits, and there's no wonder that the markets have caught up,'' Abbott said. ``What's going on here is a structural change.''`
A substantial investment has been made in mining, smelting and refining which guarantees more than adequate supplies in the future. According to ISCG, between 2006 and 2011 world mine capacity will grow from 17m tons to 22m tons, smelter production will go from16.3m tons to18.8m tons and refinery production will increase from 20.6m ton to 25.2m tons.
If neither speculative, investment nor fundamentals reasons are driving the price of copper towards its all time highs, what is? Could it be that manipulation has returned from its decade long sabbatical?
How confident are you that that the copper market has not been manipulated? If you are confident that there is no such illegal behavior it would be a good idea to tell the LME’s users why.
“Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth.”
Arthur Conan Doyle, Sr. creator of Sherlock Holmes.
Yours truly,
David L. Threlkeld
President
July 1st, 2008