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March 2019Report End of month report / chart

A Tale of Two Markets

For nearly 150 years, the London Metal Exchange, and CME’S NYMEX, and Comex Exchanges have been the center of global metal trading, each with a long, colorful, and distinguished history.

Interestingly, while both bourses had their early roots in different markets, it was during the second Industrial Revolution, between 1870 and 1914, with rapidly growing demand, and trading of metals, particularly copper, that metals became the main focus of attention.

Although the two exchanges began within just a few years of one another, they had very different contract specifications, structures, and methods of trading.

For example, the London Metal Exchange, established in 1877 had a pricing system based upon a three-month contract, reflecting the time it took for copper to travel from Chile to England. Despite a much shorter transit time today, the three-month price methodology still remains in place.

Also, while the LME used to trade in Pounds Sterling per metric tonne, today it trades in U.S. dollars pmt, and the base unit of measure for trading and statistics is in metric tonnes of 2,204.62 pounds.

Whilst the LME had long and ardently professed adherence to customs and traditions, its owners / partners, nevertheless sold the 135-year-old institution to the Hong Kong Exchanges and Clearing (HKEx) in 2012, for $2.2 billion.

From 1841 until 1997, Hong Kong was a colony of the United Kingdom. Following the ‘Handover’ to China, Hong Kong became the ‘Hong Kong Special Administrative Region’, and is officially a part of China. Also, the Special Administrative Region of Hong Kong owns 5% of HKEx.

On this side of the Atlantic, the New York Mercantile Exchange was formed in 1882, to facilitate the trade of agricultural products. Over time, the exchange became known as NYMEX, and incorporated metals and energy into its portfolio.

Also, in 1882, the New York Iron and Metal Exchange, and Iron Metal Limited merged to become the New York Metal Exchange. Three other exchanges existed at that time, to include the National Raw Silk Exchange, the Rubber Exchange of New York, and the New York Hide Exchange.

In 1933, Comex was established when these four exchanges were merged into one single entity.

1994 saw the merger of NYMEX and Comex, under the NYMEX name, but it remained a partnership structure until 2006, when an initial public offering was arranged. As a result, part of the company become listed on the New York Stock Exchange, with other parts sold to private investors, and to the Chicago Mercantile Exchange (CME), which has now become the world’s largest futures exchange.

As might be expected, the two leading metal exchanges have been fierce rivals over many years, as each one strives to grow their share of the global market.

This was particularly evident when the LME opened warehouses in the United States some twenty years ago to compete directly with Comex, and more recently, when the CME Group listed contracts for aluminum, lead, and zinc, along with approving warehouses for delivery of metal in Belgium, Spain, Malaysia and Rotterdam, among other locations.

Also, both exchanges have been working diligently for several years to attract trading business for steel, the world’s largest metal market in terms of volume.

As a member of the Comex Advisory Committee when Comex initially launched the Aluminum Contract, I was certain, beyond a shadow of a doubt, that it would be an overwhelming success, because the United States was the world’s largest producer and consumer of aluminum at that time.

And to me, at least, it made perfect sense that the domestic market would embrace a futures contract that was geared to their specific trading requirements, pricing, and settlement structure, as well as coinciding with the trading day in North America.

Further, the Comex structure of having trading months rather than specific dates, provides not only greater transparency and flexibility, but it is also a more simple, straightforward, and cost-effective approach for the user. Said another way, Comex is more user friendly.

As an example, if on March 8, 2019, I bought a May futures contract at $2.90, and sold it on March 15th at $2.91, my profit would be 1¢ on 25,000 pounds, or $250, less commission on each side of the trade.

That same transaction on the LME would require four trades as follows: Assume I bought a three-month copper contract on the LME on March 8th at $6,368 pmt, it would have a prompt date of June 8th. After the long position is established, I have no means to independently see the ‘mark to market’ value of that trade. Necessarily, I would have to call my broker to quote the spread for my specific trade date.

Going a step further, if I entered a stop loss order to protect my position, the order would be entered against the three-month date. So, if I placed a sell stop at $6,425 on March 12th, and was filled that same day, I would now have a short position with a prompt date of June 12th.

At this point, I am long 1 contract at $6,368 for prompt June 8th, and short 1 contract at $6,425 for prompt June 12th.

Now, I have to call my broker to get a quote on the spread to sell the June 8th date, and buy the June 12th date, and I have to pay commission on all four sides of the transaction.

As an aside, the entire Comex transaction was done electronically, as was the initial purchase and sale on the LME. But the spread trade necessary to close out the LME position requires one, if not more phone calls.

Which looks easier to you?

On a separate but equally important issue, it was observed on these pages a few weeks ago, that LME copper inventories rose 74,650 mt over a 48-hour period. As a point of reference, one day of global copper production is approximately 64,400 mt.

Although we did not go too deep into the details then, it is worth taking a closer look at them now.

On March 13th, 32,550 mt was delivered into warehouse in Rotterdam. On the following day, 24,450 mt was delivered into Busan South Korea, and 16,650 mt into Kaohsiung Taiwan. There were other stocks moved in and out, but these are the main ones.

There are several questions that arise from this. First is the issue of transparency. Currently the LME publishes Total Stocks, Open Tonnage, and Cancelled Tonnage on a daily basis.

Ostensibly, this information is provided to give the market an overview of the actual availability of metal.

That is to say, the cancelled tonnage represents metal still in warehouse, but is destined to be delivered out, and the open tonnage is that which is still available.

However, one can only assume the large quantities that appeared as ‘delivered in’ a few weeks ago were already physically within the warehouse, but its presence was not being acknowledged.

Wouldn’t the market be well served to know that metal arrived into a warehouse but is not yet on warrant? This is just as important, if not more so, as knowing how much metal is on warrant, but has been cancelled.

Also, was it one organization that delivered the metal in? Was it a few entities working in concert? Or was it simply a coincidence that these significant tonnages were delivered around the world simultaneously?

We won’t even get into the problems that many companies encountered in trying to remove their metal from LME warehouses over the past several years.

Comex, on the other hand, in its reporting system publishes Registered (warranted), and Eligible (non-warranted) metal. Thus, the market has a complete picture of metal availability, and there are no surprises of significant quantities of metal just showing up.

We have been asked many times over the years, why the Comex aluminum contract did not succeed like the LME contract.

Some people say of the LME “we’ve always done it that way”, others say the LME was there first, and has the liquidity, and global warehouse system, also, LME brokers provide credit lines,

As for me, I never had a good answer for that question, because I thought then, as I do now, that the United States, the world’s second largest consumer of metals, should have a strong, thriving, futures market. A market that is available to all participants, globally, on a level playing field, who demand transparency, and a simple, but robust system, that can be depended upon consistently over time.

John E Gross
March 31, 2019