Storm and a teacupToday?s historic metal prices are being set on...

Storm and a teacup

Today?s historic metal prices are being set on an exchange whose methods themselves are steeped in history, writes Europe correspondent Peter Wilson
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May 27, 2006
AT precisely 12.30pm each business day, 11 men in dark suits sit down on a round, red leather bench in London to trade copper between themselves for just five minutes.
That five-minute session of the London Metal Exchange is modelled on the centuries-old practices of merchants who once met in London coffee shops, but it has become one of the most important gatherings in the 21st century global economy.

The outcome of that meeting shapes official commodity prices, which directly influence everything from the strength of the Australian dollar to US share prices and the production plans of factories in China and mines in Chile and Indonesia.

And with copper now leading commodities on one of their strongest and most volatile booms in history, the low-profile LME has become a giant copper-core spark plug igniting the world’s currency, equity and commodity markets.

Australia’s commodity-sensitive dollar has been particularly prone to fluctuations on the LME, and the Australian stock market has also reacted strongly to trading results in the exchange’s grand Edwardian stone building on Leadenhall Street.

Ninety to 95 per cent of the world’s contracts for base metals are traded in this gentlemen’s club of an exchange, and their prices have been doing unprecedented things. Copper prices are four times what they were just 2 years ago, and record daily rises of up to 10 per cent have been immediately followed by tumbles of almost the same proportion.

“I have been working on the exchange for 17 years and I have never seen anything like this,” trader Andrew Silver said yesterday.

“Everyone is walking around shaking their heads and saying the volatility is crazy,” said Silver, who works for Natexis Metals, one of the 11 “Category One” firms whose representatives are allowed to sit on the exchange’s red bench.

“There was a very volatile period back in 1996 but copper prices were $US2500 - they are now more like $US8000 so a hell of a lot more is at stake today.”

Fuelled by rising industrial demand in China, India and other developing economies, and a tidal wave of investment and speculation from hedge funds and pension funds, the hunger for commodities has seen the gentlemen’s club of the LME become an unlikely glamour market.

When copper hit a record $US8800 on March 11, it had doubled in just 10 weeks, and even after a solid correction in the past two weeks to $US7980 the red metal is still up 81 per cent since the start of the year.

Societe Generale analyst Stephen Briggs, who has studied the exchange for 20 years, says the commodities boom is a mirror image of the hi-tech boom of the 1990s.

“Back then nobody wanted mining shares or boring old commodities, everybody wanted tech stocks – now it’s the other way around. It’s not that commodities are the best thing since sliced bread; they are the best thing since the last type of sliced bread.”

While the tech boom made Wall Street more frantic than ever, the new international focus on commodity markets has had a different effect on the LME. Traders and dealers say that instead of becoming a furious hive of yelling traders, the LME has been more quiet and nervous of late.

“Prices are so high and things are so volatile that a lot of people have been scared on to the sidelines,” said Natexis Metals trader Silver.

“We keep hearing that traders and users of copper are running down their own stocks to try to avoid paying prices like this.

“So volume has been extremely low, and that in turn makes it even easier to spook the market. The higher it goes the more volatile it gets, and any piece of news can move prices dramatically.”

A miners’ strike in Mexico, expanded consumption plans in China and mining problems in Chile have all sent recent jolts.

The exchange was formally set up in 1877 but it traces its origins and some of its unique operating practices to the Royal Exchange, which opened in 1571 as the first place where metal traders met on a regular basis.

Some 24 or 25 Category Two members are allowed to trade over telephones and computer terminals throughout the day but the most important price setting work is done by the 11 Category One members who sit looking at each other on the 6m-diameter round bench of the main trading room.

While more modern exchanges have operated “pits” in which traders wear loud jackets to identify themselves and jostle around screaming their orders, the LME rules are more sedate. Only one dealer from each firm is allowed to sit on the bench at a time; they have to sit in a designated area; and everybody knows everybody anyway so there is no need for garish outfits. Chewing gum is banned and suits are mandatory.

The trading floor, called the ring, opens at 11.45am with five minutes trading in copper, followed by five minutes each in non-ferrous metals like aluminium, zinc, tin and nickel.

That structure and the name come from the early 1800s when there were so many merchants, ship charterers and commodity traders crowding into the Royal Exchange that many began gathering in city coffee shops to do their own specialised trading.

The Jerusalem Coffee House became popular among those interested in metals, and that is where the “ring” system was born. A merchant hoping to sell metal would draw a circle in the sawdust on the floor and call out “Change”, prompting others to stand around the circle and make their bids.

At 12.20pm, when the modern traders have traded each of the major metals, there is a 10-minute break.

At 12.30pm they begin another ring session, and it is this second five minutes of trading in copper and each of the other metals that determines their official daily price.

Around 1.15pm, when the official prices have been set, the traders have a 15-minute session known as a "kerb" in which they can trade any metal.

The name comes from the 19th century merchants' habit of continuing to trade on the kerb or footpath after spilling out of the exchange.

The afternoon session follows the morning's pattern, with two rounds of ring trading beginning at 3.10pm, ending with a 25-minute kerb session which finishes at 5pm. The ring system has survived in the age of 24-hour computerised trading because the major players in this relatively illiquid market believe the best way to establish a true market price is to bring representatives of the major buyers and sellers together for concentrated, face-to-face sessions to provide enough volume to better gauge demand and supply.

Another historic hangover that distinguishes the LME from other exchanges is the nature of its benchmark copper contract, which promises the delivery of the metal exactly three months after the deal is settled. Oil, on the other hand, is traded on a less specific time frame, such as a contract to deliver oil in a particular month.

The LME system comes from the fact that merchants importing metals to feed Britain's industrial revolution wanted to sign forward contracts to reduce the risk that came with not knowing when their ship would come in, or what price its cargo would fetch on arrival.

The opening of the Suez Canal in 1869, just eight years before the LME was set up, had slashed the shipping time for tin from Malaya to match the three months delivery time for copper from Chile, and contracts for that time frame still provide today's benchmark price.

The exchange's original aim - to allow producers and consumers to find fair prices and reduce risk from price fluctuations - has been overtaken by the arrival of speculators and investors. Less than half of one per cent of all trades on the exchange now result in the actual delivery of metal to somebody who needs it for a car part or some other industrial use, according to LME head of marketing Adam Robinson.

Real producers and consumers blame speculators for the current record prices and have urged the LME to clamp down on speculation. "That is where the growth in the LME has come from: the much greater interest from hedge funds and pension funds," said Societe Generale's Briggs.

"Pension funds decided two or three years ago that they have to have exposure to commodities in their portfolios and they have become a potentially permanent source of demand. That could be a major structural change for commodity prices."

The exchange is now considering its own structural change. Having seen less influential markets and exchanges attract lucrative takeover offers and public floats, its board told members two weeks ago that it had begun pondering ways "to maximise economic value for the members".

The New York Mercantile Exchange, for instance, which sets the oil benchmark West Texas intermediate contract, has seen its trading seats valued more highly than places on the New York Stock Exchange. With its own members standing to pocket windfalls of millions of pounds, this is one tendency of 21st century exchanges that the conservative and club-like LME is likely to embrace.