Isra-Mart srl:Volume not the only metric of success for LME

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Trading volumes on the London Metal Exchange ( LME) surged to a record high in September, bringing the year-to-date growth rate to an impressive 22%. This is, of course, a key metric for assessing the health of any exchange.

And it's certainly been a timely development for the LME, which has just opened itself up to potential bidders. Speaking at the annual LME Dinner, chief executive Martin Abbott cited rising volumes and the "spectacular" capacity for further growth as both the reason why the LME has attracted bidding interest and why a successful bid will have to be "compelling" to persuade members to relinquish 134 years of independence.

But this year's volume figures provide a more nuanced picture of how the LME has been performing than the headline growth rate might suggest. And they also raise the more fundamental question of whether the LME is in danger of disconnecting with its traditional user base.


NEW CONTRACTS STRUGGLE

The massive trading turnover in September itself should come as no surprise. The 45-percent jump in volumes over last year resulted from the most dramatic cross-metals sell-off since the dark days of late 2008. The entire trading landscape was rent asunder as previously bull markets such as copper witnessed wholesale capitulation.

That doesn't negate the strong underlying trend but year-on-year growth rates have been highly divergent across the LME's portfolio of contracts. For example, that which has seen the fastest growth this year has not been flagship copper or super-liquid aluminium but lead.

Volumes in the heavy metal were up by 46 percent in the first nine months. At first glance this may be a surprising development but consider the fact that the lead contract has been subject to a rolling front-date squeeze for much of this year.

The motive of the perpetrator remains perplexingly obscure but the net result has been massive inflows of metal to LME sheds and stellar trading volumes. At the other end of the scale lie the LME's two newest contracts, molybdenum and cobalt. Volumes in the former rose by an anaemic 0.5 percent in the January-September period. Cobalt volumes fell by 9 percent. It was the only contract to experience negative year-on-year growth rates.

Indeed, even those figures are slightly misleading. The two minor metal contracts were only launched in February 2010, meaning the year-ago figures covered one less trading month.

The LME argues that new contracts always take time to gain traction, which is undoubtedly true. However, outright trading volumes, particularly in molybdenum, suggest little or no traction whatsoever in the underlying physical markets.

Even more troublesome for the LME is the performance of its "mini" contracts, so-called because they are only a fifth the size of the primary contracts. After failing to take off in London, they were relaunched in conjunction with the Singapore Exchange ( SGX) in February of this year,

Volumes on the SGX have dwindled alarmingly over the last three months. Combined turnover for copper, aluminium and zinc was just 1,186 lots in September, compared with 38,922 lots in March, the first full month of trading. Unless reinvigorated, and soon, they risk mirroring the original London offerings, which briefly flared into life before slipping into dormancy. They haven't traded since May.

MISFIRING STEEL

At least steel billet volumes are still growing, up 39 percent in the first nine months of this year. But the growth rate has been steadily falling and it is hard to avoid the feeling that all is not quite right with the LME's first foray into the ferrous sector. An unusually high level of cancelled stocks in the LME system, currently accounting for over 80 percent of total billet stocks, suggests the arbitrage between financial and physical markets is misfiring.

The steel market, by far the largest of any global metals market, seems to be increasingly embracing iron ore swaps as the preferred method of hedging its risk. SGX swaps volumes, for example, were up by 110 percent in the first nine months of this year and, in stark contrast to LME billet, the year-on-year growth rate is still accelerating.

The common thread here is the LME's struggle to extend its offering beyond its core base metals suite, particularly into the steel sector which is crying out for hedging tools after the collapse of the annual benchmark pricing system. It's hard to see any of these newer contracts generating the "spectacular" growth promised by Abbott, but then maybe he was referring to the LME's forays into the world of "post-trade services", a trend that has culminated in plans to set up its own clearing house.

Such a move, the LME promises, would be highly "value accretive" for its members. But it's hard to see how it will be "value accretive" to its existing industrial user base or how it will help the LME tap the massive new metals market that is the steel sector.
GHOSTS IN THE MACHINE

Nor is it clear that the LME's traditional business, servicing the needs of the metals industry, is the reason for strong trading growth even in the core base metals. The LME doesn't provide any breakdown of the type of trading behind its volume figures. But most on the LME "street" in London are in no doubt as to where the extra volume is coming from. Concerns about the proliferation of algorithmic high-speed trading have been rising steadily over recent months to the point that Abbott confronted them head-on in his LME Dinner speech.

"The fact is that we must stay current with market developments if we are to remain the dominant centre of liquidity," he told guests at the Grosvenor House hotel. Staying "current" means offering proximity hosting for the LME's Select electronic trading platform, allowing super-speed algo traders even faster execution.

Whether that adds "liquidity" or just volume is a moot point. Just ask an LME broker, who must navigate the quantum world of evanescent single-lot bids and offers to execute an order.

The volumes generated from this new breed of trader come at a price, a sense of increasing alienation among the producers and consumers whose business underpins the LME's role as pricing mechanism for the global metals industry.
WHOSE METAL? WHOSE EXCHANGE?

The real fault line between the LME and its traditional user base, though, runs through Detroit, where the wait to remove metal from the market of last resort is measured in months. Annoyed that you're paying historically high premiums for physical metal even while millions of tonnes are sitting in LME warehouses?

Frustrated that if you actually need metal from the exchange, you have to join the back of the queue in Detroit, even if you want your metal somewhere else? Blame Ben Bernanke for printing all that free money. Blame the big bad banks for financing what's on LME warrant. But don't blame the LME.

Abbott's spirited defence of the LME's warehousing system is not necessarily wrong. But it doesn't address the core issue of how the system is no longer giving the metals consumer the option of accessing quickly the metal held in LME-registered warehouses.

And it's not just aluminium. If you want zinc or copper out of Detroit you're still caught in the aluminium queue. And it's not just Detroit. Other locations, such as Johor, are starting to see the same thing. The LME, Abbott said, is "working on it". Good. Because if the LME stops being a physical delivery option for metals consumers, it will lose much of its relevance. Volume figures are one metric for assessing the health of the LME. There is no metric for assessing how healthy the LME's relationship is with the industry that has made it what Abbott called "the world's premier base metals market".