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18 November 2015

Plus ça change....

Some things change; others look for a while as if they are doing so, but, standing back, we get to see that actually they are but a part of the cyclical flow of events. 


I can remember, a long time ago, how a friend of mine at university tried to explain to me the (as then pretty much unknown) meaning of silicon chips. He knew what he was talking about - I hadn’t a clue. I couldn’t see what was so special about being able to put digital electronic circuitry on what I could only think of as a piece of sand. Why would you spend your time finding out how to do that? Now, of course, I understand. When I was at school, we had a computer (I say we, but actually I mean those who were studying A level physics). All I knew about it was that it filled a room, probably used more electricity than a village and could do sums just a bit quicker than I could in my head. But as I sit here, in front of a laptop that cost about £1300 and enables me to do so many of the things I want, I’m eternally grateful to those people who persevered with that electronic research. That stuff has genuinely changed the way we approach day-to-day life. (And, incidentally, it’s also boosted the consumption of metals we’d almost never heard of when I began my career, which in turn has produced a healthy living for lots of my friends who trade these things.)

'New Paradigm'

Back around the turn of this century, it was fashionable - amongst some - to hail the arrival of a ‘new paradigm’ in commodity markets. What they were suggesting was that the shift in demand created by China’s rapid development was going to change the metal markets for ever. It was never seriously a realistic proposition, particularly clear if you understand the nature of the balance of supply and demand and the elasticity (or not) of those concepts, but it had its supporters. What we in fact saw was a very strong, sustained rally, eventually running out of steam as the underlying economic realities developed. In fact, metal prices now are closer to where they began than where they reached and, as someone pointed out to me recently, the BHP Billiton share price is pretty much back down where it was when the China rally started. As an aside, it’s quite interesting that what seems very complex and difficult - advanced technological development - is something that we humans can in fact grasp and work with, whereas what on the surface looks much more straightforward - keeping control of the price of commodities - is outside our abilities. Must be a lesson here somewhere.

Changing possibilities

So, one area of change, and one just looking like it for a while. But both of those developments have had a profound effect on the way the market has evolved since the beginning of the twenty-first century. Think of it this way. The speed of the development of computing power has become faster and faster since my friend in the mid-70s first mentioned it to me, and in the first decade of this century that resulted in a huge surge in the use of that power in the financial services industry. Of course, prior to 2000 there were plenty of quantitative funds using mathematical computers, but the real qualitative change came about with the ability to use computer algorithms to trade directly on electronic exchanges facilitated by that same exploding computer power. Suddenly, the possibilities of trades were no longer constrained by human ability to process those trades; volumes, and therefore the amount of money involved, could increase far above what had previously been possible.

At the same time that this ability to trade on a much bigger scale emerged, the markets effectively locked on to a very strong trend upwards - predicated mainly on China’s seemingly endless demand for industrial commodities. So, what looked like a one-way market (as it was, for a while) and the ability to pour vastly greater sums of money into it. What could have been more appealing to the financial institutions? And grab it they did. Sure, there had been banks involved in the commodity business before - and certainly in trading, not just in traditional lending and financing - but this was the opportunity for the banks and financial investors to channel lots of money into a previously rather specialised  area. Metals, commodities generally, became the hot, trendy area of investment. The ‘new paradigmers’ were sure it was going to last for ever.


But, and here we come back to my theme of things that change and things that behave cyclically, it didn’t. The evolution of the market reached a point where supply and demand became too unbalanced, and natural forces brought the trend to an end. The fall-out from all this is where we are left. The big money has gone - for the moment - because it wasn’t a new game that would last for ever. It was a very strong, long trend; that was great for the investors, but when the trend broke and the down-cycle began, it was time to get out. There are other games to play. So the influx of banks into the market turned to an overall exodus. 


The interesting bit, though, is that the market has not just reverted to how it was. The genuine change - as opposed to one side of a cyclical wave - wrought on it by the development of electronics is here to stay, and that has implications for market participants. With the departure of the banks, perhaps we could have expected the traditional broking fraternity to re-assert its position. But that has only partially happened, because their function has at least to an extent been overtaken. What I find significant is the number of experienced and (relatively) senior LME operators who have spotted that electronic trading and the electronic dissemination of information have opened up opportunities to be far more receptive to client wishes outside the monoliths that regulation and technology costs have pushed the major broking houses to become. 

It’s an interesting development, and I expect to see more of these specialist independents developing. And it’s all happening because of changes some of which were real and some were only transitory.

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