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This piece feels ... confused. It starts off with casually assuming that pricing mechanisms "just don't work" for a commodity, which sets a bad tone, but is for

by SilasX 5y ago

This piece feels ... confused. It starts off with casually assuming that pricing mechanisms "just don't work" for a commodity, which sets a bad tone, but is forgivable if it can deliver. But then I got to this part[1]: >What caused the price spike? The largest nickel producer in the world, a Chinese company called Tsingshan, was short nickel because it had made a huge capital investment and was set to produce 40% more nickel in 2022 than it had in 2021. ... But what if prices go up? Isn't a short dangerous? Not really if you're short nickel and you're a nickel producer. ... Your shorts are "covered" rather than "naked," so your losses are limited. Okay, so far so good: Tsingshan took a short position, which was safe, because it's covered, by virtue of them being a producer of the underlying (nickel). >They're limited, that is, so long as you can deliver nickel against the contracts. But what happens if ... closing your short is going to require you to deliver $10s of billions of nickel, and you're going to have to come up with $1s of billions immediately because of margin calls. You don't have that kind of cash on hand, and you can't deliver a huge chunk of your production up immediately against those short contracts. So ... the shorts weren't actually covered, and you can expect to suffer huge losses if the price goes up. I still don't see the case for voiding the transactions, since the price movement was responding to real macroeconomic phenomena, and the short-seller couldn't actually cover. [1] I've cut out large pieces of the quotes to get the point quickly, while doing my best to preserve the meaning

lbarrow 5y ago
I agree with you on the limitations of the article, and I can see the rise in nickel prices due to the war as "real macroeconomic phenomena", but the short squeezes on nickel produces clearly created a positive feedback loop that pushed the price way higher than the fundamentals justified. Voiding the transactions here serves the same purpose as a circuit breaker on a stock exchange: to prevent temporary pricing feedback loops from causing chaos. If the LME had a circuit breaker (and I'm sure they'll be getting one soon), this wouldn't have even come up.
kasey_junk 5y ago
I largely think it was a mistake to break the trades. That said you can make a logical argument for it if you presume that the LME thinks their job is to act as a price discovery mechanism for “real” nickel instead of acting as a bastion of the LME nickel futures contract. Nickel in the real world does not actually meet the contract specs very often (this is true of most commodities). The bigger issue than the liquidity position of Tsingshan is that they produce nickel that doesn’t meet the LME contract spec. They aren’t perfectly hedged due to this, but they continue to be a major driver of nickel prices in the real world. So if the market was orderly their nickel production should trivially offset any short position they have (and it did with a day or two of looking for financing). From the LME’s perspective, letting Tsingshan, a producer with no evidence of trouble producing nickel fail because of a quirk in the matching engine of LME, when the macro factors should be making them tons of money, is dramatically worse for the natural nickel market than breaking the trades of the speculative participants. In any commodities market the speculative participants dominate the order volume, but the real producers and consumers are the backbone of the price discovery mechanism. If Tsingshan pulled all their future volume out of the LME due to this, it would both destroy the market and hinder future price discovery for nickel. It’s understandable that the LME would take extraordinary action to prevent that. The real question is why they didn’t have circuit breakers in the first place, and thats mostly a culture issue.
- SilasX 5y ago
  Those all seem like legit problems that need to be handled, but none of them justify LME's super-corrupt "solution" of "take-backsies for big/high-status traders, but brutal market discipline for Gary Greentext on WallStreetBets". Don't like short squeezes? Then don't allow naked shorting (which, contra the confused author, this was). The trades could have been satisfied but for an extra transaction? Natively support the transaction. The nickel doesn't meet the spec? Create a new category for it, or don't support it to begin with. In no case is a sane solution to play favorites with overleveraged traders.
  - kasey_junk 5y ago
    I’m super sympathetic to the argument that the LME overreached here (and if I made my living trading there I’d be reevaluating my participation). But I don’t believe this was as corrupt as you are claiming. First naked shorting in commodities futures is a completely different proposition than in equities. Failure to deliver in commodities can be quite literally the risk you are trying to hedge. The market is supposed to account for this! The idea that a market should atomically support every form of financing independent of company fundamentals is perhaps a goal to work towards but not anything market participants believe exists. And as for nickel not meeting the contract? This is a classic case of a continuous signal having to meet a discrete measurement goal. When, where, why and how you assay are important for the discrete signal but both unnecessary and overly complex for the real world goals. Most of the nickel in the world doesn’t meet LME contract spec (neither does WTi crude for that matter) but that doesn’t matter so long as the market displays orderly pricing, to remove that assumption is to destroy commodities futures markets.
    - MrMan 5y ago
      the LME is plainly and explicitly trying to protect natural traders in this one outlying instance, because they dont have the flexibility that speculators do. I recently started to trade some contracts on LME after many years of considering it too archaic to contemplate, but its a great source of liquidity for many metals and cant at least up until now be neglected. there is no reason another exchange couldn't subsume some of the trade on the LME, but the tension between speculators and natural traders won't go away.
kristjansson 5y ago
Unless the producers carried a speculative short in excess of their production, I don’t think it’s right to say they weren’t covered. They have the next x months/years of production sold forward, and produce enough to fill those contacts over that period. However they have to post margin on the entire position at the current market price, which creates the liquidity crunch. If they ignored the margin requirements, they’d fill the contracts over time as planned, eat a paper loss on the price the they could have sold the metal at, and be a little bit sad. If the margin rules are enforced, they have to come up with a bunch of cash, or close the position
- SilasX 5y ago
  If you can’t cover the position, you’re not covered. They couldn’t cover the position. Anything else is overcomplicating it.

by SilasX 5y ago

lbarrow 5y ago

I agree with you on the limitations of the article, and I can see the rise in nickel prices due to the war as "real macroeconomic phenomena", but the short squeezes on nickel produces clearly created a positive feedback loop that pushed the price way higher than the fundamentals justified. Voiding the transactions here serves the same purpose as a circuit breaker on a stock exchange: to prevent temporary pricing feedback loops from causing chaos. If the LME had a circuit breaker (and I'm sure they'll be getting one soon), this wouldn't have even come up.

kasey_junk 5y ago

I largely think it was a mistake to break the trades. That said you can make a logical argument for it if you presume that the LME thinks their job is to act as a price discovery mechanism for “real” nickel instead of acting as a bastion of the LME nickel futures contract. Nickel in the real world does not actually meet the contract specs very often (this is true of most commodities). The bigger issue than the liquidity position of Tsingshan is that they produce nickel that doesn’t meet the LME contract spec. They aren’t perfectly hedged due to this, but they continue to be a major driver of nickel prices in the real world. So if the market was orderly their nickel production should trivially offset any short position they have (and it did with a day or two of looking for financing). From the LME’s perspective, letting Tsingshan, a producer with no evidence of trouble producing nickel fail because of a quirk in the matching engine of LME, when the macro factors should be making them tons of money, is dramatically worse for the natural nickel market than breaking the trades of the speculative participants. In any commodities market the speculative participants dominate the order volume, but the real producers and consumers are the backbone of the price discovery mechanism. If Tsingshan pulled all their future volume out of the LME due to this, it would both destroy the market and hinder future price discovery for nickel. It’s understandable that the LME would take extraordinary action to prevent that. The real question is why they didn’t have circuit breakers in the first place, and thats mostly a culture issue.

SilasX 5y ago
Those all seem like legit problems that need to be handled, but none of them justify LME's super-corrupt "solution" of "take-backsies for big/high-status traders, but brutal market discipline for Gary Greentext on WallStreetBets". Don't like short squeezes? Then don't allow naked shorting (which, contra the confused author, this was). The trades could have been satisfied but for an extra transaction? Natively support the transaction. The nickel doesn't meet the spec? Create a new category for it, or don't support it to begin with. In no case is a sane solution to play favorites with overleveraged traders.
- kasey_junk 5y ago
  I’m super sympathetic to the argument that the LME overreached here (and if I made my living trading there I’d be reevaluating my participation). But I don’t believe this was as corrupt as you are claiming. First naked shorting in commodities futures is a completely different proposition than in equities. Failure to deliver in commodities can be quite literally the risk you are trying to hedge. The market is supposed to account for this! The idea that a market should atomically support every form of financing independent of company fundamentals is perhaps a goal to work towards but not anything market participants believe exists. And as for nickel not meeting the contract? This is a classic case of a continuous signal having to meet a discrete measurement goal. When, where, why and how you assay are important for the discrete signal but both unnecessary and overly complex for the real world goals. Most of the nickel in the world doesn’t meet LME contract spec (neither does WTi crude for that matter) but that doesn’t matter so long as the market displays orderly pricing, to remove that assumption is to destroy commodities futures markets.
  - MrMan 5y ago
    the LME is plainly and explicitly trying to protect natural traders in this one outlying instance, because they dont have the flexibility that speculators do. I recently started to trade some contracts on LME after many years of considering it too archaic to contemplate, but its a great source of liquidity for many metals and cant at least up until now be neglected. there is no reason another exchange couldn't subsume some of the trade on the LME, but the tension between speculators and natural traders won't go away.

kristjansson 5y ago

Unless the producers carried a speculative short in excess of their production, I don’t think it’s right to say they weren’t covered. They have the next x months/years of production sold forward, and produce enough to fill those contacts over that period. However they have to post margin on the entire position at the current market price, which creates the liquidity crunch. If they ignored the margin requirements, they’d fill the contracts over time as planned, eat a paper loss on the price the they could have sold the metal at, and be a little bit sad. If the margin rules are enforced, they have to come up with a bunch of cash, or close the position

SilasX 5y ago
If you can’t cover the position, you’re not covered. They couldn’t cover the position. Anything else is overcomplicating it.