"The [London Metal Exchange’s] history dates back to the early 19th century, when metal traders drew a circle in the sawdust on the floor of the Jerusalem Coffee House in the City of London. Today, in addition to its electronic market, it’s one of the last exchanges where brokers still gather in person to yell orders at one another for part of the day." [1] [2]
This piece feels ... confused. It starts off with casually assuming that pricing mechanisms "just don't work" for a commodity, which sets a bad tone, but is forgivable if it can deliver. But then I got to this part[1]:
>What caused the price spike? The largest nickel producer in the world, a Chinese company called Tsingshan, was short nickel because it had made a huge capital investment and was set to produce 40% more nickel in 2022 than it had in 2021. ... But what if prices go up? Isn't a short dangerous? Not really if you're short nickel and you're a nickel producer. ... Your shorts are "covered" rather than "naked," so your losses are limited.
Okay, so far so good: Tsingshan took a short position, which was safe, because it's covered, by virtue of them being a producer of the underlying (nickel).
>They're limited, that is, so long as you can deliver nickel against the contracts. But what happens if ... closing your short is going to require you to deliver $10s of billions of nickel, and you're going to have to come up with $1s of billions immediately because of margin calls. You don't have that kind of cash on hand, and you can't deliver a huge chunk of your production up immediately against those short contracts.
So ... the shorts weren't actually covered, and you can expect to suffer huge losses if the price goes up. I still don't see the case for voiding the transactions, since the price movement was responding to real macroeconomic phenomena, and the short-seller couldn't actually cover.
[1] I've cut out large pieces of the quotes to get the point quickly, while doing my best to preserve the meaning
I largely think it was a mistake to break the trades. That said you can make a logical argument for it if you presume that the LME thinks their job is to act as a price discovery mechanism for “real” nickel instead of acting as a bastion of the LME nickel futures contract.
Nickel in the real world does not actually meet the contract specs very often (this is true of most commodities). The bigger issue than the liquidity position of Tsingshan is that they produce nickel that doesn’t meet the LME contract spec. They aren’t perfectly hedged due to this, but they continue to be a major driver of nickel prices in the real world. So if the market was orderly their nickel production should trivially offset any short position they have (and it did with a day or two of looking for financing).
From the LME’s perspective, letting Tsingshan, a producer with no evidence of trouble producing nickel fail because of a quirk in the matching engine of LME, when the macro factors should be making them tons of money, is dramatically worse for the natural nickel market than breaking the trades of the speculative participants. In any commodities market the speculative participants dominate the order volume, but the real producers and consumers are the backbone of the price discovery mechanism. If Tsingshan pulled all their future volume out of the LME due to this, it would both destroy the market and hinder future price discovery for nickel. It’s understandable that the LME would take extraordinary action to prevent that. The real question is why they didn’t have circuit breakers in the first place, and thats mostly a culture issue.
Those all seem like legit problems that need to be handled, but none of them justify LME's super-corrupt "solution" of "take-backsies for big/high-status traders, but brutal market discipline for Gary Greentext on WallStreetBets".
Don't like short squeezes? Then don't allow naked shorting (which, contra the confused author, this was).
The trades could have been satisfied but for an extra transaction? Natively support the transaction.
The nickel doesn't meet the spec? Create a new category for it, or don't support it to begin with.
In no case is a sane solution to play favorites with overleveraged traders.
I’m super sympathetic to the argument that the LME overreached here (and if I made my living trading there I’d be reevaluating my participation).
But I don’t believe this was as corrupt as you are claiming.
First naked shorting in commodities futures is a completely different proposition than in equities. Failure to deliver in commodities can be quite literally the risk you are trying to hedge. The market is supposed to account for this!
The idea that a market should atomically support every form of financing independent of company fundamentals is perhaps a goal to work towards but not anything market participants believe exists.
And as for nickel not meeting the contract? This is a classic case of a continuous signal having to meet a discrete measurement goal. When, where, why and how you assay are important for the discrete signal but both unnecessary and overly complex for the real world goals. Most of the nickel in the world doesn’t meet LME contract spec (neither does WTi crude for that matter) but that doesn’t matter so long as the market displays orderly pricing, to remove that assumption is to destroy commodities futures markets.
the LME is plainly and explicitly trying to protect natural traders in this one outlying instance, because they dont have the flexibility that speculators do.
I recently started to trade some contracts on LME after many years of considering it too archaic to contemplate, but its a great source of liquidity for many metals and cant at least up until now be neglected.
there is no reason another exchange couldn't subsume some of the trade on the LME, but the tension between speculators and natural traders won't go away.
I agree with you on the limitations of the article, and I can see the rise in nickel prices due to the war as "real macroeconomic phenomena", but the short squeezes on nickel produces clearly created a positive feedback loop that pushed the price way higher than the fundamentals justified.
Voiding the transactions here serves the same purpose as a circuit breaker on a stock exchange: to prevent temporary pricing feedback loops from causing chaos. If the LME had a circuit breaker (and I'm sure they'll be getting one soon), this wouldn't have even come up.
Unless the producers carried a speculative short in excess of their production, I don’t think it’s right to say they weren’t covered. They have the next x months/years of production sold forward, and produce enough to fill those contacts over that period. However they have to post margin on the entire position at the current market price, which creates the liquidity crunch. If they ignored the margin requirements, they’d fill the contracts over time as planned, eat a paper loss on the price the they could have sold the metal at, and be a little bit sad. If the margin rules are enforced, they have to come up with a bunch of cash, or close the position
Why? Everyone agrees it was a short squeeze that led to predatory pricing. It’s a much bigger social good to reverse transactions than to bring charges against all the sellers for price gouging.
Your type of reply is common with people who want to avoid the very real question of why the rules are bent when trades go wrong for certain people. Please tell me why you think somebody who shorted nickel so heavily to the point that they almost went broke deserves a bailout.
I'm fine with supporting bailouts for the social good. I just think that the shareholders of the bailed out companies and executives should personally lose assets. Not necessarily sufficiently to pay for the bailout but to act as a real discouragement.
They did and will lose money on their bets, just not ridiculous amounts that don’t reflect the real market price. Also the bailouts we’re talking about here are loans to nickel miners to cover margin calls, not free money. They will make money selling nickel at a higher price.
Yes, that’s me. First time anyone has recognized me.
One of my rules is that prices that have increased by 3 times in a few hours with no real change in demand and most suppliers still producing, then it’s not a real price.
The problem was the callable short. They had nickel coming in N months. They could fulfill it then. They just couldn't take a short position that would be fulfilled then - instead it had to be fulfilled randomly before then.
> the shareholders of the bailed out companies ... should personally lose assets
if shareholders lose assets, then it's not a bailout. If they get bailed out, then they aren't losing assets. You're talking about the same coin, viewed from different angles.
What you wish to accomplish - the shareholders taking a haircut, but for third-parties such as customers or general public to not take one, is impossible.
Market makers have an important function in providing liquidity even in the absence of underlying asset.
However this can create unusual and aberrant situations that certainly warrant raising these sort of questions in order to determine appropriate regulations and rules
This is an expensive way to say "they give you money maybe, even for nothing". That last part is the problem - if that is their core role, they should not exist. Even if they make some folks a lot (more) money.
Market Makers are basically the financial system's buffers: they exist to make sure that you can always buy or sell a given security/commodity. They are the people who make buying or selling something _immediately_ possible, rather than having to wait for someone who needs what you're selling (or is selling what you're buying) to come along.
This makes trades move quickly, which speeds up price discovery. This is good for market health.
Market makers make their money on the difference between the buy-sell spread. Of course, this is a bet: if the market moves against them, they can lose money on this. Often a market has one or more officially designated market makers who are paid to _always_ have a certain number of both buy and sell offers on the market to ensure that there is always liquidity. The payments help cover their risk
(These payments are often also materialized in the form of a "takers fee", i.e. a surcharge you pay whenever you place an order into the market which can be immediately filled)
TL;DR: They're a warehouse which will always buy and sell some product, except when talking futures we're talking wagons full of nickel 1 month from now and so the warehouse doesn't physically exist
What you're describing to me sounds like a scam. Of course this is a normal scam that everyone accepts as part of life, but that doesn't mean I have to feel the concept belongs in the modern world.
Do you think bridge loans are a scam and should be removed from modern life? What about insurance?
Fierce competition by market makers mean that for commodities producers and consumers they don’t need to go to investment banks to get bespoke insurance & loan products. They can instead use the market extremely cheaply.
This means that it’s less risky to produce nickel or use it in industrial/commercial processes.
That in turn is not just an efficiency improvement it allows pricing oddities like this one to stay in the realm of wonky finance news. Without the exchanges and market makers the commodity supply chain would lurch and halt, and we’d have stories about how no smartphone batteries will be available in 2023.
If it's as truly a scam as you seem to think, wouldn't you think it also strange that many participants willingly participate in this system?
It's not like there's a gun to the heads of producers and traders. Market makers are also usually not a single entity. Traders could trade amongst themselves in a different exchange that bans market makers. And yet no such exchange exists (as far as i know - except over the counter exchanges perhaps, which not many people use).
I’m not here to argue the finer points of the merits or ethics of capitalism with you, but the fact is that under our current system they provide a very important and essential function. Your ideological approach to rebutting the facts as I stated them don’t change anything and in fact belie an immense ignorance of the functioning of the modern economy - you and all those who also decided to throw a downvote out of ignorance
While I recognise that they are a thing that exists (and this is not something you can change), you appear to claim:
A. To understand how the "modern economy" works
B. It cannot work without one system
Both claims are very big claims, and while they could be true they are nowhere near so obvious that you can say that it belies an "immense ignorance" to think that this system is bad.
Is price gouging in this context illegal (genuine question, I know very little in this area, but I would not have thought so). It seems to me like they are effectively just selling at the price the market will bear, which is artificially inflated at present.
In what way can one force someone to sell at a price you want them to. Is it price gouging if I refuse to sell to you a commodity that you really want if I think I can get more out of it?
Is there such a thing as price gouging for metals and is that illegal?
The exchange being able to roll back trades in extraordinary circumstances is also part of the game. The exchange obviously has a strong incentive not to abuse this power or the traders will find another exchange.
If your team loses the basketball game, the rest of your high school hates you.
If you lose your job, you lose your health insurance.
If you bet on the wrong part of the roulette wheel, you lose your chips.
If you miss your rent, you get evicted.
In all these endeavors, if you screw up you suck up the consequences, end of story. I feel literally no pity for traders who got margin called, they're forced to buy nickel to cover their short positions but they're just not worthy victims, they're debtors. And these are expensive people, these traders took out those loans to buy proof of their superiority, like cars, houses, jewelry for wives and affairs, investment-type goods like watches...maybe one of them was smart enough to buy Magic cards, but if they get short-squeezed, I doubt it.
To my knowledge these traders are consenting adults, 18 and up surely, they gambled and won and took their money, this time they gambled and lost. They have to pay, with nothing but silence from them.
In commodity markets it's usually the producers of commodities who hold short positions as hedges.
If the price of Nickel skyrockets, their shorts will lose money but their inventory will also become more valuable. But due to the nature of the instrument, they need to come up with additional margin for mark to market losses. This isn't a question of solvency but of liquidity.If there's a short squeeze and the price gets completely disconnected from fundamentals, the producers and the brokers might go under and speculators who held long positions will make a massive profit. I don't see how that is more socially useful than the exchange stepping in to correct a market failure.
The participants in commodity markets produce literal tangible goods, it's not a casino.
If the price of nickel goes up, nickel miners go out of business because they hedged their bets? I guess they were consenting adults who should have realized they could fold if their assets became too valuable? Because nickel is so expensive we just have to produce less of it, because they deserve punishment for gambling.
Or we can just act like real consenting adults and agree that markets break every once in a while leading to outcomes that are bad for everyone. And thus we can reverse these outcomes. Even casinos have rules, and have reversed winnings or losses.
That logic runs both ways, you could just as easily say:
Well, the short squeeze traders knew the risks - they knew that LME had the legal authority to cancel trades in extraordinary circumstances, they made the trade anyway and boom that's exactly what happened. They gambled and lost; they have to pay.
This version has the advantage that it respects the actual rules under which trading is done, rather than inventing a new set of rules which aren't used, as a vehicle of ressentiment.
No. The nickel trading is designed to insulate nickel mining and nickel consumption from prices. The nickel miner has nothing to do with the short squeeze unless of course he is also a nickel trader, but by design the short squeeze has nothing to do with the mining, the explosives they use, the chemicals they mix, none of it.
The consenting adult thing is a joke. These aren't 19 year old college students who are spending student loans irresponsibly, and need debt forgiveness or relief. These are 50 year old men mostly, millionaires, lots of degrees saying they're smart, and lawyered up to the teeth. And the appearances they put on, and the new jargon they are introducing (desynchronization?) is similar to how the public had to be "educated" about "toxic loans" which is really a PR move to pass their losses to others. They lost money, that's it.
They're exactly like a gambler who thinks he has a system, like the martingale, meaning double your money when you lose, reset when you win. So they make a lot of money for a while and it looks really cool, they look like badasses when they lose a bit, double their bet, lose again, then double their bet again and this time they win and they think wow, how did we come up with such a great system, we have such a bright future ahead of us, let's go squander the winnings.
The LME should be as strict as a casino. You don't want to give up your chips after you lost? Security! And six guys show up from different directions. But it won't, LME would rather play favorites, and what this loss of integrity means is the exchange will lose the appearance of integrity. Basically giving up their dignity to Shanghai.
The whole purpose of the LME is to cheat countries that are constantly being raided out of the only thing that can't be stolen in one shot, their natural resources. England can steal all the silver of the Chinese Emperor, but they can't move mountains. So they say, oh, you have a lot of natural resources! If you want manufactured goods you can sell those and buy the goods with that! What should the price of these rocks be? I know a perfect system, very prestigious and it's never gone wrong, high integrity, and it happens to be in London.
To paraphrase the head of the LME during this episode, it’s a market, not a casino. It serves a real, social purpose: move metal from producers to users, and move risk to those who can bear it. The rules and structures of the exchange are a human system built in to achieve that purpose.
If the rules have a weird interaction with world events and threaten entire artifice, they should suspend the rules.
And what happens when the biggest nickel producer in the world needs to buy nickel from someone (non-existent) else? That's not about short squeeze, that's about the market almost ceasing to exist because market is far from perfect. The point here is: if they don't rollback, there is no money for the winner.
It's an interesting reading and I think you should read.
I think it's basically just replacing having a circuit-breaker -- if they had a circuit breaker like a lot of other exchanges, the crazy price jump never would have gotten going.
I don't think circuit breakers should exist. And markets should operate 24/7. There is absolutely no good reason why they wouldn't in digital age. Players should not make bets where they can lose too much money.
You can hedge short positions. Ekaros is saying that traders shouldn't rely on things like circuit breakers or rollbacks to save them when they make a bet with too much on the line.
In this case the hedge was going the other way. They hedged their real long position with short futures. The market broke and they were in a position where they were losing money as the price of their real asset was sky rocketing.
This is because of the natural limits of hedging short positions.
Circuit breakers aren’t designed to protect traders from betting too much, they are designed to prevent the market itself from breaking in unforeseen ways.
Matt Levine is generally great, the nickel coverage was great but if you read those posts you'll also see the sections where he keeps writing about how Russia will default on its debts. Then when the opposite happened he didn't even comment on the conclusion of that previously important topic let alone admit there must've been faults with his analysis.
Big portions of his readers might not even learn he was wrong and this kind of blatant sweeping of wrong conclusions under the rug makes authors look much more accurate than they are.
>Yeah, I don’t know, I mean. If Russia doesn’t pay interest tomorrow, or pays it in rubles, will that “shut the country out of most funding markets”?
>So the likely outcome is that Russia will not pay interest on those bonds, or will pay it in rubles. And then those bonds will be in default. And Russia will say “we’re not really in default; our default was caused by the mechanics of the international financial system, not by our unwillingness or inability to pay.”
and so on. Except Russia paid their debts the next day and didn't default. Apparently he has actually later mentioned that they paid but mostly just as something that's confusing him why so part of my criticism was unwarranted.
This is unrelated to the parent topic directly, but I just read that article in 6 minutes. I saw this comment before I actually read the article, so I was reading at a normal speed rather than just skimming, to retain enough that I feel like I could explain it to someone else if I had to. That video is 20 minutes long! I know people seem to prefer to consume information from a video vs just reading about it but it kind of struck me that the article was described as "lengthy" and the video was described as a "summary".
The robin hood fiasco presumably made more of a main stream impact because it was a "fun" human interest story rather than just a dry technical thing that was a problem, then got fixed, and most people never cared about and definitely will never remember a year from now.
Basement dwelling internet nerds win big over wall street!
vs
Over leveraged Chinese mining company gets a loan!
The video is specifically about the nickel issue. As for it being 20 mins, i argue that it's only longer because speaking is so much slower. The informational content is less in the video. And i also recommend watching videos at 2x speed!
Sure, and the past week is proof of the folly of daily limits.
LME has added limits. So every day, the nickel market opens, drops 8%, and then closes immediately. No one gets to trade, because everyone knows the price of Nickel hasn't reached its "logical" value yet. So these price limits are a de-facto long-term close of the market until the dollar value matches what people want.
So in effect, you've closed the market for days (weeks?) since no trading activity takes place to "correct" the price shock.
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I mean, its a terrible situation for the nickel market, but I don't think hard price limits like this are a good idea either. After closing the market for a week (presumably long enough to fix whatever political-glitch was going on), it would have been better to just let the price float to whatever it was, instead of this "lurch 8%, close the market" kind of situation.
Most exchanges have circuit breakers. LME is old fashioned in lots of ways and being late to circuit breakers is one way. They’ll have them going forward.
[1] https://www.bloomberg.com/news/articles/2022-03-14/inside-ni...
[2] https://www.youtube.com/watch?v=VOvA5HWdbmc