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08 August 2013

New Aluminium Wars

“Aluminium Wars” is a phrase familiar to those of us who were around and dealing in Russia during the first part of the 1990s; if we posit legal action as the closest thing to war in our civilised society, perhaps it’s one we’re going to have to start using again.

Lawsuits are beginning

Certainly the lawsuits are beginning to fly, first of all targeting Goldman Sachs and the LME and now, I understand, aimed at Glencore, J P Morgan and other (as yet) unnamed defendants who may be joined to the action. The allegation seems to be that the actions of one or more of the parties named may have resulted in aluminium consumers paying more for their metal than might otherwise have been the case. The issue of delayed metal – caused by warehouse queues – is also considered, even though it is difficult to discern too many large consumers caught in those queues. It may, of course, be very illuminating to see details of the ownership and destination of the cancelled warrants which are responsible for causing the queues.

Who supplied the metal?

Now, what I find interesting about this is that the complainants do not appear to have been buying metal from the defendants. The contractual relationship would seem to be between the buyers on the one hand and various aluminium producers or traders on the other. Presumably, the pricing conditions incorporated some form of LME base price plus delivery/location premium. It seems slightly odd, therefore, that the lawsuit concerning, effectively, an alleged requirement to overpay for goods does not include the party who was setting the price and selling those goods. Is it the case that some of those unnamed potential additional defendants will be the traders and/or producers who actually contracted with the complainants to supply metal? This issue becomes more complex when you consider that what one might call the ‘guilty’ metal – in other words, that sitting in the warehouse for which a high incentive has allegedly been paid – must also have come from somewhere. That somewhere, logic tells us, is likely to have been, either directly or via a trader, from a very similar range of producers who have also sold to the complainants. So actually, this legal war is between the consumer half of the aluminium industry on one side, and the producers and financiers on the other. The headline names of course are the bogeyman banks and the City of London institution; but I can’t see how it can avoid being widened as I suggest, because it is very difficult to believe that the blame lies entirely with the warehouses. Presumably, producers also had some say in negotiating the premium at which they were selling to them.

Will the Courts understand pricing?

Then there is the issue of the actual price. We all know that the underlying price is hedgeable – if desired – and the premium element is not. That makes the premium disproportionately significant, compared with the percentage of the final price that it represents. However, that’s a thorny point to persuade the courts to understand. Expert witnesses can explain and explain, but in my experience (and I genuinely have some in this, although pretty limited, I admit) judges and courts tend to look at the total price. In this case, therefore, they are going to be presented with a picture of a declining overall price (because the LME price has dropped further than the premium has risen) at precisely the time when the allegation is that customers have been obliged to overpay. I understand the logic, but it may be a tough one to prove.

That’s one side of the issue – that it’s an argument between producers and financiers on one hand and consumers on the other, and that anyway absolute prices declined during the period in question.

A different perspective

However, there is another side to it, equally worthy of consideration. I have said many, many times before that the build-up of stocks in warehouses is not a good thing. Industrial metals – and we can extend this beyond aluminium to cover zinc, where the warehousing game seems to be being played, and copper, where ETFs have threatened to withdraw metal from circulation – should not be gambling chips in a storage game; they are produced to be consumed by productive industry. It is nonsensical to extract ores from the earth, smelt and refine them into primary metal and then lock that metal away in a warehouse for years.

Combination of circumstances

The responsibility for this state of affairs, though, lies with a particular combination of circumstances. The decline in consumption in 2008, together with a reluctance to cut production in response, coincided with a governmental policy of very low interest rates and the creation of huge quantities of new money. Those factors resulted in a situation ripe for exploitation. Having said that, though, it does not necessarily mean laws or rules have been broken. We can say, with the benefit of hindsight, that the LME should probably have acted more quickly to amend the rules, but in fairness to them it was difficult to see how big the brewing storm would become. Again, it’s convenient to point the finger at the banks and warehouses, but the rules permitted what they have been doing. Personally, I don’t think it is a good idea to have the bank/broker/trader monoliths owning warehouses, but at the moment the rules allow it. As I have been saying for over two years, allowing cheap money to distort the non-ferrous market is in the long run in nobody’s interest. Changing the environment in which it has happened is what needs doing; whether lawsuits based on existing rules will succeed will be interesting to see.

Were laws broken?

So, it’s a confused picture. The market has been distorted, and certainly we can see who appear to have been the beneficiaries. Whether that distortion happened as a result of breaking of laws and collusion between parties is far less clear; maybe a pointer will be to see how big the class of complainants gets.

One final random thought; if, in 2008,instead of taking the warehouses’ shilling, producers had elected – independently – to cut production substantially, and that had resulted in prices remaining at significantly higher levels, would they have risked a similar lawsuit? In other words, how far can one party’s attempts to sustain its own business be regarded as a legitimate target for another party?

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