I recently went to see “The Wolf of Wall Street”; I found it
absolutely hilarious, and I strongly recommend any readers who have not yet
seen it do so. Don’t, incidentally, do what a very good friend of mine did,
though; he took his 15 year-old daughter, believing it to be a film about
financial scams. It is, but, as the UK ‘18’ certificate suggests, it
encompasses a lot of gratuitous hedonism along the way. My friend ushered his
daughter out after the first five or so minutes.
The underlying story is of how investors can be persuaded to
punt almost anything, given the right sort of sales approach, whether or not
they understand the proposition put before them. I find that quite intriguing.
Broadly, why would you speculate on something where you have only a very
limited amount of (or in some cases, absolutely no) relevant information? Or,
to put it differently, if you want to bet on pure chance, why not stick to a
casino or a lottery? We (all?) understand that in a casino the house will over
the long term invariably win – otherwise, the casino wouldn’t be there; but we
still play. Well, that’s probably OK, but when it comes to less frivolous
speculation – the sort we like to dignify with the name of ‘investment’, where
hard-earned, or inherited or whatever wealth is put on the line – why would you
take the risk with gaping gaps in the amount of information you have? The
punters in the film soak up the protagonists’ made-up sales spiel, and live on
dreams of getting lucky. Back to the casino, really.
And in Metals?
So how much information do we have when we invest in metals?
For sure, there are plenty of analysts who do a splendid job of crunching
supply and demand numbers; that should be what we need, no? Actually, that
would be only part of it. Technical analysts, using behavioural sciences and an
element of psychology, pick the pinch-points of fear and pain which usually
indicate potential price reversals. So there’s a good basis of understanding.
But there are some big drivers of price at the moment that are either not specifically
related to metals, or are shrouded in mist. Prime amongst the second category
is the true level of stock and the reality versus the illusion of consumption.
In a recent article (‘What Goes Up, Must Come Down’), I
mentioned the use of metals as collateral for loans in China. Well,
think about this. The steel industry in China is suffering; there is clear
overproduction which has led to a glut of product and declining prices. The
export market won’t take all the excess, either. And yet, iron ore imports are
still running strongly, even as prices drop. Likewise copper; the gap between
raw material import and actual production is too large simply to be ignored as
grit in the system. It is clear that substantial quantities are being imported
as chips in the financing and loan business. The shadow financial sector has
taken up the slack as state-backed banks have been required to tighten credit,
and raw materials are widely used as collateral. Incidentally, the rising
activity on the Fanya Exchange would suggest minor metals as well are being
used as investment chips and not just as part of the industrial supply chain.
So, industrial raw materials are being used as financing
tools, rather than going straight into consumption. Does that matter? Well, in
the absolute – in other words, as a matter of right or wrong – of course not.
We have always known that speculators will use metals as a vehicle. To go back
to The Wolf of Wall Street, does it mean metals investors and/or speculators
are acting like the ignorant (in the sense of not knowing information, rather
than the pejorative sense) punters the film’s characters feed on? Again, of
course not. But we have heard a fair amount of clamour from various sources
asking for the LME to publish commitment of trader reports, as though those
will miraculously clear the fog that surrounds the opaque nature of commodity
markets; well frankly, I would suggest that a better understanding – which,
granted, will be extremely difficult to grasp – of the amount of metal held as
collateral against what may very well turn out to be non-performing loans would
be far better information. Of course, there are those who may well have a
pretty good grasp of that number – one major hedge fund with very strong links
into China springs to mind, and I suspect that there are a few physical traders
out there who are internally aware of what is going on, but in general, I would
be very cautious; this is a bubble, with potentially – mark that, potentially,
not clearly – a pretty strong threat. How it will play out is by no means clear
– and the treatment by the Government of failing ‘investment trusts’ will be a
pointer – but I fear it will not end well.