The LME Dinner 2016 – and God Bless America?
The social and commercial whirl of the LME Dinner Week is now over for another year; were there any overall themes or expectations to the conversations, discussions and debates had by participants? (Obviously, this is going to be subjective, since I can only comment to the extent of my own involvement.)
Since the function of the LME before anything else is as a price discovery mechanism, I guess the most significant question is the one that is always the first on anybody’s lips: will the price go up or down from here? I understand, of course, that all the metals have their own individual price trajectory, but nevertheless it’s a valid approach to consider the whole class together. And this year, there seems to be a fairly chunky majority giving the same answer to that question. Mostly, those to whom I spoke expect the next price move to be upwards. Actually, in the circumstances, that’s not too much of a surprise. The market has been wallowing for most of the year so far, unable to see clearly amongst the global mix of Chinese demand, Brexit, the US election and the seemingly endless low interest rate/QE-heavy economic policies being followed by many of the major players. All of those factors, I would argue, have to one extent or another contributed to a directionless market. However, although it’s directionless, it is so at a relatively low level. It is true prices have improved from a while back where production and sales cost were disturbingly close for many producers, but broadly at current levels, there is more space on the upside than the downside. Certainly the straw poll taken around the table where I was sitting last Tuesday night was modestly optimistic, on that basis. The balance of probabilities favours up a bit more than down, without any of my fellow-diners being significantly more optimistic than that. There are, however, as well those more positive, looking for a significant upswing on the back of resurgent demand and – perhaps more pertinently – looming supply side issues. Well, OK, some looking modestly firmer, some more positive than that; what I didn’t find was too many on the negative side.
Where there is a lot less commonality of thought is the question of the direction of the LME itself – in other words, the institution – and its likely future. Michael Farmer made some very pertinent comments in his speech, concerning the current cost of trading and the influences right now bearing on the Exchange. Now, I’ve heard lots of debate about costs, and I have some sympathy with both sides. It was inevitable after the purchase of the Exchange that the new owners would raise fees, in order to recoup some of their investment (otherwise, shareholders might have become unhappy); so it wasn’t unexpected, and, frankly, to an extent, the executive have listened and made some concessions. However, it still remains true that the LME is – in relative terms – an expensive exchange. One could argue that in a way that is irrelevant, within reason, as long as the unique nature of the LME’s trading structure is of sufficient appeal to its users. In other words, if the market offers something not available elsewhere, and it’s something users particularly want, then surely it can charge a premium price?
Well, yes, that’s a good argument. But then we look at the second part of Michael Farmer’s point above; the influences currently acting on the Exchange, in particular the growth of algorithmic and high-frequency trading. I would suggest that those traders have very little interest in the date trading structure of the LME: certainly in the case of the latter, given the short term of position holding, it’s pretty much irrelevant. So there is a delicate balance to find here, because those purely financial and electronic traders do have alternatives and, although like-for-like comparisons are not so straightforward, it would appear that CME’s market share, in copper for example, is growing relative to the LME’s. And there is Shanghai out there, and, lurking in the wings, the possibility of other trading venues. This is a difficult one for the LME, because the new volume it needs to keep growing will have to come from precisely the areas of the business which have the greatest sensitivity to the cost of trading. In the end, although the trade may moan and groan, the cost of its hedge is a less crucial element of a particular trade than it is for a high-frequency trader going in and out on the slenderest of price movement – and that trade doesn’t need the LME’s unique structure.
Algos and AI
Computerised trading came up as a topic of conversation amongst the group with whom I dined last week. They were made up of physical traders, warehousemen and LME brokers, all frankly from what could be called the senior generation. I made what I thought was a relatively uncontroversial statement that I could envisage not only a growth of algorithmic trading but also a burgeoning control of that trading by artificial intelligence. It wasn’t a popular view. The physical traders maintained that electronic devices would not be able to replicate their particular range of skills. In fact, I agree with that, and my point was directed at exchange trading, not the physical arena. But the LME brokers were also not convinced, and argued for the pre-eminence of personal contact. Well, I think there is, amongst other things, a generational issue here. Plenty of us grew up in an era where the broker saw his task as keeping the clients informed of the general market; news, information, price changes – passing all these on was a crucial element of the broker/client relationship. But in a world where all that news, all those snippets of information, all those price changes are disseminated virtually instantly across the world, then the need for that close relationship – in my view – is severely weakened. In the end, I think this is a generational issue, and as those of my generation bit by bit bow out of the business, then electronic relationships will progressively replace the personal. If I’m right about that, then it’s a small jump – in understanding, even if a big one in technological development – to a position where AI is increasingly used to harvest news, information and price changes to make trading decisions. I believe we are getting very close to the beginning of that change in the world. To be fair, though, I have to confess that mine was a minority view at my dinner table.
Anyway, there are a few observations from last week. Quite positive on price, a difficult balancing act for the LME and – maybe – only a few steps from a radical change to the way the market works and the way we understand it.
Writing this on the day of the US election, I couldn’t not say something about it. I offer my heartfelt sympathy to American friends. In the summer of this year, we had a referendum on membership of the European Union. I knew what I instinctively thought, but the campaign behind it was dire. The other side had a weaker case and an equally dire campaign. It was a disheartening exercise, and nothing that’s happened since has made it look much better. But now look across the Atlantic: if I were voting, I would be voting against somebody – as the worse of two evils – rather than for somebody. That’s a terrible state to reach.
The period of English history in the twelfth century covering the reign of King Stephen and the civil war between him and his cousin, the Empress Matilda, is sometimes referred to as the time “when Christ and all his Saints slept”. I don’t know about saints sleeping, but God, whom we are told should bless America, must be looking the other way at the moment.
Writing this morning, after seeing the result, it looks like it’s not just America from whom He is looking the other way. Where have the grown-ups gone?