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03 August 2016

Physical Metal Exchange?



A long time ago, back at the beginning of this century, there was a business called Emetra, which aimed to be a kind of one stop electronic trading shop for base (and, I seem to recall, some precious) metals. Quite a lot of money was ploughed into developing the trading platform, but eventually the cash ran out and the whole thing flopped. The people behind it, though, were well-known and respected in the business, and the presentation was certainly well-structured and convincing. My guess - and it is only a guess - as to what really went wrong would be first, that they were trying to do too much too soon, rather than develop incrementally, and then that the cost of software development in those days was still very high. 

A few years later - maybe around 2006/7 - I occasionally commuted on the train with one of the leading lights of the Climate Exchange. I didn’t know him well, and just chatted from time to time, which is where I learned of the existence of the Climate Exchange, of which I had until then known nothing. But I missed the point; I looked at it as a trading exchange, like something I was familiar with. What I didn’t grasp was that it was actually a mechanism for buying protection against extreme weather events - of interest to agriculture, tourism and the like. May of those behind it came from an insurance background, rather than a commodity trading one, and that was what powered it. It was subsequently sold (to ICE, I seem to remember) for a pretty large chunk of money.

Wrong

The reason I mention those two things is to caution readers of what follows. I was wrong in both cases; on the one hand, I believed Emetra would succeed - it seemed eminently reasonable, as markets began to migrate on-line - and on the other, I couldn’t see how the Climate Exchange could succeed - because I largely missed the purpose of it. So I was a hundred percent wrong; best prepare your pinch of salt now, before reading the rest of this, because I approach the subject with some trepidation.

Physical Metal Trading Platform

Anyway, a group called Metalprodex, based in Germany, is planning to launch a physical metal trading platform in the very near future. It styles itself a physical metal exchange, which some may see as a gauntlet thrown down to the LME. I have said several times before that I expect the LME to face challenges in its space as technology and communications advance, but I am surprised to see the first of those coming from the physical market. It is true that there is a segment of the LME’s natural client base that resents the way the Exchange has - in pursuit of volume and growth - opened its arms more widely to the financial community, but I’m not sure how this offering could be construed as a response to that.

Metalprodex will trade a spot (two-day) contract in four metals - copper, aluminium. lead and zinc, and will only allow trades for parcels of metal which are already in an accredited warehouse. There will, therefore, be no possibility of short selling (or indeed hedging). All trades will be between members - who will pay a membership fee as well as a “commission” - and the contractual partners will be the buyer, the seller and the warehouse. Metalprodex will have no contractual role in a trade. Metal will be either duty paid or duty unpaid, and there is a brand list for the various metals (which looks remarkably familiar, speaking as an LME trader) to determine deliverability.

Sound Familiar?

All sounds quite reasonable - buy metal in warehouse, take delivery two days later. What could be better? But doesn’t that - like the brand list - seem familiar? I don’t quite see what this is offering that is not already available, on the LME. It is of course the case that the LME physical delivery mechanism has had a painful few years as it has struggled to control the warehouse issue, but light does finally seem visible at the end of that long, dark tunnel, even if there are still lawsuits lurking. If nothing else, the timing seems off - and anyway, surely the same problem could arise on Metalprodex, if circumstances and supply/demand coincide again in the same way? 

What the LME has found, though, with its hundred and thirty-odd years of experience, is that actually only a small portion of the overall trade results in the physical uptake of metal. There are number of reasons for that, but I would suggest that the most important one is that not too many metal consumers run their business on the basis that they will buy metal at two days notice; in other words, it is rare that the buying decision is not appreciated well in advance. It may be that the three months LME contract evolved because of shipping times from the other side of the world, but what it also offered was the ability for buyers to plan and make their purchases in a timely fashion, using the LME as a price protection, or hedge, mechanism. The MD of Metalprodex is reported to have said: “There is no other physical metal exchange and it is clear that there is a demand for one.” Mmm. I disagree with the first half of that statement, and I would need convincing that what demand there may be would be satisfied by a platform which would appear to preclude long-term planning. Crudely, the ability to take metal up from the LME is an important part of the Exchange, but I am sceptical that it is significant enough to found a business on.

Two or Three Dimensional?

Equally, why would a producer be prepared to produce metal, ship it and put it into warehouse before being in a position to sell it? Again, the ability to trade forward is a crucial part of the way the non-ferrous business works. It seems perverse to take what could be described as a three-dimensional market and deliberately reduce it to two dimensions; but I may, of course, be missing something…..

So I have my doubts about Metalprodex; bear in mind, though, the opening couple of  paragraphs to this - my track record is dubious. 





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