Record high metals prices crimp market liquidityThursday 11 May...

Record high metals prices crimp market liquidity
Thursday 11 May 2006, 9:00am EST
By Martin Hayes

LONDON, May 10 (Reuters) - Leading base metals have repeatedly scored record highs this year, with copper, zinc, aluminium and nickel far exceeding expectations, but these high prices are hurting liquidity on the London Metal Exchange (LME).

Traders said rapid and unprecedented price moves are being seen more frequently now, but the amount of actual business is much less than when the markets were lower a year ago.

"Obviously, the market is where it should be. But, at the extremes, it is difficult to trade -- and that applied to the downside as well, as I recall," a veteran floor trader said.

This year, the upward price moves have been particularly savage -- since January 3, zinc is up 87 percent, copper has gained 83 percent, while aluminium is up 35 percent.

"These moves are scaring the trade people away -- they are getting very nervous," Angus MacMillan, minerals strategist at Bache Financial, said.

On the LME, the world's largest non-ferrous metals market which is still dominated by open-outcry trading, copper hit a record $8,060 a tonne on Wednesday, aluminium reached $3,077, its highest for 18 years, while zinc notched its best ever at $3,565.


RECORD DAILY MOVEMENTS

Intra-day movements have also expanded. On May 4, copper prices rose near $600, or 8.2 percent -- the largest ever daily gain, with a $200 mid-afternoon move taking place in turnover of little more than 150 to 250 25-tonne lots. "There are times during the afternoon -- around 1400 to 1500 -- when there is hardly any liquidity, and that's when it can be driven quite sharply," another senior floor trader said.

Base metals, precious metals gold, silver and platinum, oil and some agricultural products like sugar have all been swept higher in a two-year commodity bull market, fuelled by asset-switching buying from hedge, macro and pension funds.

"It is dangerous for the exchange in the long-term, but there is not a lot that they can do. The funds are the flavour of the month at the moment, but what happens when they are not," MacMillan added.

The almost unbroken trend of rising prices has made selling, apart from profit-taking, risky. Many short-sellers have been burnt, having to cover at loss-making higher prices.

So there is now less selling pressure when markets move -- typically a bid for 20 or 40 lots will see an offer of five to 10.

Also, industry producers, who use futures to hedge-sell and lock in prices, are unwilling to trade.

"For the trade customer, it is particularly acute -- short hedges have to be lifted and the market is nearly always going against them. So they are less willing to get involved now," the second trader said.


FALSE IMPRESSION

LME turnovers are up, with the exchange likely to see a record volume this year. Jan-April total volume was 32.5 million lots, up from the year-ago 24.4 million.

But traders said this creates a false impression -- much of the business involves spreads, which are simultaneous buy and sell orders that involve rolling existing positions forward.

"A lot of that now is these funds moving their big positions

-- it's double-counting, and it is also revenue-neutral for us, as there is little or no commission income," a third trader said.

Business on the LME's Select electronic trading system has also tailed off, compared with earlier in the year. Screen trading is favoured by investment funds.

The current daily screen record of 45,083 lots was set in February this year. But that was when business was more 'two-way' -- at that time the LME was being hit by speculative profit-taking, met by other speculators topping up positions.

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