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22 February 2013

Time for HKEx and LME to perform

With the cash for the London Metal Exchange deal from HKEx actually being paid in the penultimate week of December last year, there were no doubt many champagne corks popping over Christmas and New Year in the homes of the lucky recipients.

Now, as we get into the year, the performance will have to begin.

The measure of that performance will, I think, be very simple: it will be the volume, the number of lots that trade through the LME’s various access points – that is, the Ring, LME Select and the telephone, this latter being of decreasing significance.

Given the growth shown by the LME over the last ten years or so, it will be a tough job just matching it, let alone outdoing it. One would hope, therefore, that conditions through the global economy would be set fair to aid that task. I wonder, though, if that’s the case.

The big selling point of HKEx as a bidder for the LME was its ability to push the business further into China and capitalise on that country’s hunger for risk management in its vast metal-consuming sector. That sounds fine, and clearly the Hong Kong-based entity has a strong understanding of the needs and wants of the Chinese mainland.

However, I can’t help but feel that actually the decision as to how much of that latent pool of business is desirable lies more with the Exchange members than with its owners. It will be the members who have to bear the credit risk of their counterparties, and who will therefore ultimately decide whether or not to take that risk.

I am reminded of a Chinese contact of mine at a large trading company, who told me once he would like to buy an LME broker, because in his words: “I have 2,000 customers waiting to use the market, which no western broker can access because you can’t understand them enough to give them trading facilities.”

That understanding will grow over the years, and the presence of HKEx will help it along for sure. But for the moment it will still act as a brake on the development of the business. However, that is an issue within the control of the members. They can decide their stance with regard to future business for themselves.

What is also going to play a big part in how volume behaves this year is governmental policy. I have written several times before about the pernicious overall nature of QE – governments creating more money to put into the economy – and its effect on wealth and the value of money.

Because of the way that QE devalued money, it has had a correspondingly beneficial effect on the price of hard commodities, among other things. It makes it better to hold solid things rather than paper money.

In my view, the easy availability of QE money has been a major factor in supporting metals, particularly copper, over the last year or so. It has also supported bond prices, and left the equity markets a little bit out in the cold.

Since the beginning of this year, though, the FTSE and the Dow have both risen by over 5%, which I think is telling us something. It is pretty obvious that at some point, even the most profligate of governments will have to rein in their excesses and stop the printing presses (or, more correctly, the electronic money machine).

At that point, with rising interest rates, bonds will become less attractive, creating a corresponding rally in equities, since the money that needs to be invested has to find a home. It seems to me that the current rally we are seeing is potentially the market predicting the winding down of QE during this year.

The question for metals market participants, therefore, is whether metals – purely capital-appreciation assets with no income element – follow bonds down as higher interest rates raise the carrying cost, or whether they prove attractive as risk assets despite that.

Opening up China, setting up warehouses there, introducing different-currency contracts: all these are part of the HKEx vision. They are all for the future, however. The success or failure of HKEx’s first year in charge will largely be driven by volume, which will in turn in large part be dependent on governmental actions.

In other words, events outside the control of the exchange, its members and its owners.

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