In Commodity News 14/07/2016
China has loomed large over the world of industrial raw materials for many years.
The prices of metals from aluminium to zinc have long swayed to the beat of the world’s largest manufacturing nation.
But this is the year that China has emerged from the limelight to take centre-stage in the trading of those metals.
On one day alone, March 10, trading volumes on the Dalian Exchange iron ore contract exceeded one billion tonnes, more than the combined annual output of the world’s biggest three producers, Rio Tinto, BHP Billiton and Brazil’s Vale.
The following month, on April 21, more than 240 million tonnes of steel rebar traded on the Shanghai Futures Exchange (ShFE), equivalent to around a third of China’s steel production last year, not just of construction-destined rebar but of every imaginable type of steel product.
Such was the crowd surge of Chinese retail investors through the domestic commodities trading space earlier this year.
Trading conditions became so tumultuous that Chinese exchanges frantically upped margin and deposit levels to disperse the hordes.
Activity has since calmed down but no-one can be left in any doubt as to the seriousness of China’s ambitions to move from primary price-taker to primary price-setter across the industrial spectrum.
Those ambitions obviously challenge the London Metal Exchange (LME), which has dominated base metals trading for the last century.
The LME is currently fending off internal critics, who are looking at a potential new trading platform, and increasingly aggressive moves by the U.S. giant CME into the industrial metals space.
This is still something of a phoney war for the top seat at the global metals trading table, but hostilities are only likely to intensify.
Graphic on Chinese iron ore and steel trading:
SHANGHAI SURGE
Shanghai steel trading grabbed the headlines in the first half of this year.
Volumes on the ShFE rebar contract surged to over three billion tonnes in March, which even allowing for Chinese exchanges’ habit of counting both buy and sell transactions in their volume figures, is a huge number.
But it’s not just rebar. Volumes across all ShFE’s metals contracts have been booming, particularly those that had previously been shunned by local players such as aluminium, up 335 percent year-on-year, and new contracts such as nickel, up 248 percent.
Indeed, with 98 million tonnes traded in the first six months of this year, ShFE nickel volumes comfortably exceeded the 61 million tonnes notched up by the LME.
The emergence of this new liquidity hub has caused a mass relocation of nickel stocks away from the LME warehousing system into ShFE sheds, which currently hold 103,000 tonnes of metal.
This gravitational pull is exerting an ever greater influence on London nickel trading.
But Shanghai is still some way from grabbing London’s price-formation role in the global industrial metals markets.
It doesn’t yet offer options trading, a key component for price hedging strategies.
As shown by the extraordinary volume and price surges earlier this year, ShFE and other Chinese exchanges are prey both to the disruptive effects of retail speculators and of the authorities who act to dampen their animal spirits.
And more importantly, ShFE remains first and foremost a domestic market trading venue.
Its contracts are priced to include value-added-tax. It has no delivery points outside of China. It remains cordoned off from the international market-place by the country’s great wall of capital controls.
Graphic on LME volumes by contract in H1 2016:
LONDON’S MULTIPLE CHALLENGES
What ShFE has done, however, is stop any other exchange from muscling in on its territory.
When the LME was bought by Hong Kong Exchanges and Clearing in 2012, its new owners were confident they were uniquely positioned to prize open the Chinese market.
But there has been no metallic equivalent of the Hong Kong-Shanghai stocks trading pipeline switched on last year.
The LME remains thwarted by Chinese regulations from opening up delivery points on the mainland, while HKEx’s attempt to woo investors with “mini” yuan-denominated metal contracts has struggled to gain momentum. Volumes in the three main contracts, copper, aluminium and zinc, totalled 12,529 lots in the first half of this year, down from 29,895 in the first half of 2015.
The LME’s bigger concern might be its own falling volumes, down 8.0 percent so far this year.
Activity has fallen across the LME’s portfolio with the single exception of nickel, up 0.6 percent so far this year, and the new steel contracts.
The exchange blames the market, specifically the current “pricing uncertainty” that is deterring industrial hedgers. Parts of the market, however, blame the LME, specifically the fee hikes across some of the exchange’s short-dated spread structure.
A group of discontents is looking at setting up its own trading platform under the guiding hand of former LME chief executive Martin Abbott.
That may, or may not, pose a future threat to the LME franchise. A more imminent one seems to be coming from across the Atlantic.
CME THE CHALLENGER
CME is rolling out an increasing number of contracts in what appears to be a direct challenge to London’s dominance of global base metals trading.
The most successful of these have been the aluminium premium contracts. The U.S. Midwest contract, indexed against S&P Global Platts assessments, has traded 930,175 tonnes so far this year, compared with 936,175 in the whole of 2015.
The European and Japanese premium contracts, meanwhile, also appear to be gaining traction.
The LME can afford to take a sanguine view of these contracts, even if its own premium products have failed to trade at all. After all, every tonne traded on a CME physical premium contract implies a tonne still traded on the LME’s basis price aluminium contract.
More direct a challenge comes from CME’s aluminium, zinc and lead contracts, which it has added to its long-standing copper contract over the last year.
These are still struggling to build momentum. Lead, for example, has notched up just 5 lots of activity so far and that in the month of June.
But aluminium volumes have grown by 68 percent to 3,729 lots so far this year and CME copper volumes, up 22 percent in the first half in stark contrast to a 5 percent decline on the LME, offer a warning to the London incumbent. CME, meanwhile, is expanding its attack with a new aluminium alloy contract in the works.
Such is the rapidly changing landscape of futures trading in industrial metals; intensifying rivalry between CME and the LME in the west, stand-off between London and Shanghai in the east, and new contracts in all three regions.
The shift from a unipolar to a multi-polar global pricing model is not going to happen quickly, but there is a growing sense that the process is under way.
Source: Reuters (Editing by David Evans)
