A new concept seems to be creeping into the trading vocabulary - ‘malicious short-selling’ first reared its head as a problem for the Chinese equity market back in the summer. Now, it seems it’s fighting its way into the metal markets, specifically the SHFE. Well, I can sympathise with that; when I’m long, and somebody starts selling and pushing my position into a loss, clearly it’s targeted and malicious. I suspect we’ve all felt like that sometimes, on a bad day.
Metal prices have dropped a long way and if you look at the open interest figures for the SHFE, the numbers have increased quite markedly in recent weeks. So that’s been enough for a bunch of market participants - including a good number of Chinese metal producers - to cry foul to the regulators and claim malicious intent on behalf of the sellers. It looks at the moment as though they’ve scored some success and restrictions may be imposed on some short selling. Well, that may be seen as a victory by some, but I think I’d wait until the courts sort out the definition of ‘malicious’ in this context. I’m not too familiar with the Chinese legal system, but were the issue in the UK or US, some of my lawyer friends would be scenting a bonanza.
Two of the reasons I saw quoted for the need to take some kind of action intrigued me. First, a metal producer said that if the shorting wasn’t stopped, producers would have to close down because they would be making losses, and then the price would go up because supply would be restricted. Well there’s a man (or woman) who has clearly got to grips with free market economics, even if he doesn't like it. Surely that’s the point? The free movement of price is what drives the balance of supply and demand. Introducing government protection and allowing uneconomic production to continue is the best way to ensure that prices won’t rise, because the supply side will not be subject to any financial discipline. The second interesting concept was that shorting the metals like this (and nickel was specified here) was effectively taking a position against China, and internally that is something that shouldn’t be allowed. That opens up a variety of issues. First, it’s by no means clear whether China as a whole is better suited by high or low metal prices; does the benefit for the consumer of low prices outweigh the preference of the producer sector of high ones? I don’t know the answer to that, and I suspect it’s a point open to debate even at high levels within the Chinese establishment. But what it also suggests is that there is a belief that investors and/or speculators should feel an obligation to go with the flow of what could be called the future of greater China - in other words, don’t rock the boat of the government’s economic policy. That’s not a concept that would particularly find favour in the west, and indeed is arguably not truly compatible with a free market.
And quite apart from the domestic speculators - what about the (presumably) perfectly legitimate arbitrage traders, who won’t necessarily be able to point to a clear hedge, but are nevertheless making a reasonable trade? No, I’m afraid I can’t see this as anything more than a retrograde step, putting unnecessary layers of additional regulation - which will be difficult to enforce fairly - on to the market.
Those are the surface issues, but dig a bit deeper and there is perhaps something else going on - something not very attractive, but probably irreversible.
During the boom years - largely caused by China’s huge appetite for metal - exchanges and institutions around the world marketed the idea of commodity investment like there was no tomorrow. That makes sense - when your product is hot, that’s the time to make hay. So lots of speculative and investment money which had previously been perhaps reluctant to play too much in commodity markets was drawn in by the one-way bet that seemed to be available. Exchanges were upgraded and brought into the twenty-first century, all in conjunction with the huge and rapid increase in computing power. The result of all that? Lots of speculative money, pushing metals to record levels and making mining companies the darlings of the investment community and electronic trading the flavour of the month. (Incidentally, I don’t seem to recall any comments then from those producers who are now unhappy to the effect that driving nickel, say, to $50000 risked damaging the industries that use it).
Well, what’s happening now is at least in part nothing more than the other side of the coin - the cyclical reversal. But the markets were reformed to facilitate high-speed trading, and it’s that high-speed trading that is currently one of the significant unbalancing factors. I’m afraid that markets will be more volatile, will be pushed to more extremes and will be more difficult to trade; but hey, never mind, the HFTs and algotraders all form part of the metal trading community now, don’t they?
The Horse has Bolted
Introducing short selling bans is going to damage the legitimate trade at least as much as it deters the HFTs, identified by some of those currently unhappy as the source of the problem. But the stable door is swinging wide open and the horse is long gone. Sow the wind and you will reap the whirlwind.