The London Metal Exchange suspended trading in its nickel market after an unprecedented price spike left brokers struggling to pay margin calls against unprofitable short positions, in a massive squeeze that has embroiled the largest nickel producer as well as a major Chinese bank.
Nickel, used in stainless steel and electric-vehicle batteries, surged as much as 250% in two days to trade briefly above $100,000 a ton early Tuesday. The frenzied move — the largest-ever on the LME — came as investors and industrial users who had sold the metal scrambled to buy the contracts back after prices initially rallied on concerns about supplies from Russia.
A Chinese tycoon who built a massive short position in the nickel market is facing billions of dollars in mark-to-market losses as a result of the surge in prices, according to people familiar with the matter.
Some reporters 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
Putting up and holding the market a well as 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
As Nickel being 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 weeks 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.
As anyone involved in nickel knows, it may be the most unpredictable out of the three main LME contracts. The metal prices move all the time, meaning changes could be quite dramatic. The last nickel cash price of 2020 was $16,553.50/MT on Dec 31st, only to print $17,349.50/MT on the first trading day of 2021 (Jan 04th).
Towards the end of Jan 2021, Ni price went well above $18,000 before retreating below this level. There are no profit margins in physical trading that could ever absorb such price fluctuations thus even a simple spot deal that takes a few days from agreeing with the contract to delivery and payment carries significant risk.
This is where LME and SHFE come to the rescue for risk mitigation purposes (in the case of nickel). For copper, aluminum, and zinc these two exchanges are joined by CME.
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