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14 September 2016

Dropping Volumes Spell Changing Times



The volume figures just released by the LME make pretty grim reading, if you’re looking for market growth. The tally overall showed a decline in year-on-year average daily volume of around 17%, with aluminium recording an eye-popping decrease of almost 30%. Some special circumstances have been wheeled out to explain why this should have happened, but to be honest they don’t seem hugely convincing. 

First, there is the seasonal factor - lots of people are on holiday in August; well, yes, but we can’t really point to a history there, even though summer happens every year. Then we are told that the forced move of the trading floor from its Finsbury Square home to the (less salubrious? I don’t know - I haven’t been there) suburban Essex disaster recovery site while the HQ building was fixed, caused volumes to drop. I don’t quite get that; the dealing teams were in place at the DR site, and as far as market clients are concerned, unless they are using a video phone, it’s difficult to see how they would be affected. Still, let’s accept that the disruption did cause some slowdown in activity, with journeys to and from the dealing floor being more unfamiliar, and just a general reluctance to be too active under unusual circumstances. 17%  reluctance though? 

Whatever the truth of those particular issues, they can’t be used to conceal the possibly slightly uncomfortable reality of a drop in the underlying usage of the Exchange. 

It’s not, of course, the first time that has happened; it would be unrealistic to regard permanent growth as anything  but a dream. However, as I and many others have said before, the situation now is different from the past. It’s perfectly legitimate for the LME management to be confident in public that their owners do not have unreasonable expectations and that they do not exert undue pressure to create volume growth, but at some point that will be the case. For the moment, the effect of the decline in volume is to a extent masked by the growth in income generated from increased fees. That’s fine, but once that effect has worked through, it will no longer help the numbers. To keep the flow of income, the LME will need to see volumes at least maintain steady numbers, or preferably increase. 

So where can the volume come from? 

Well, it’s back to the same old discussion - either it comes from the trade, or it comes from the investment/speculative traders. Frankly, it’s difficult right now to see the former playing too much part. Overall activity shows little sign of increasing significantly in current global economic conditions and that’s what has to change to trigger greater hedge requirements. Rightly or wrongly, neither producers nor consumers see much mileage in any sort of far forward activity, and that has shrunk interest in that part of the curve. Options, which ten years ago were fuelling big positions, have dwindled away, for the similar reason that in directionless markets, they are a difficult game to play. 

If growth isn’t about to come from the trade, then, can the speculative side take up the slack? The LME have been clear that they - assisted by their shareholder - see great future potential in the Chinese market. It’s difficult to disagree with that assessment, even if we have to leave the politics and mechanics of how it can be made to happen to those with the direct contacts and political understanding. 

But, and this is where we get into a contentious area, that expansion is likely to change the overall balance of the business. By and large - in my experience - new speculative blood is not necessarily enamoured of the quirky date-trading system of the LME. And, while the Ring undoubtedly generates excitement and a desire to trade, the new players are more concerned with anytime access and a continuous market. I believe the LME when they say they don’t want to change and become another rolling 24 hour monthly trading platform; for sure, they intend to keep the Ring and the dates “as long as there is a desire for them”. But the likely changing make-up of the Exchange’s users brings the probability that the majority may not be for the status quo nearer, and that desire may be diluted. 

Reduced volumes per se are not a problem; I fully accept that position. But the logic of the changing balance of the market does seem to me to be pointing in just one direction. 

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