What Happens When the World’s Key Metal Exchange Has No Metal?

Issued at 2021-11-04

What happens when the London Metal Exchange runs out of metal? That’s the question the exchange is urgently trying to address for its flagship copper contract, which sets the global price for one of the world’s most important commodities.

The problem stems from the LME’s physical nature: anyone holding a contract to expiry becomes the owner of a package of metal in an LME warehouse. On the other hand, anyone who has sold one must deliver the metal when the contract expires.

But with available copper inventories at LME warehouses falling below 20,000 tons -- less than China’s factories consume in one day -- traders are grappling with the possibility that there simply won’t be metal available to deliver.

The dramatic drop in stockpiles that began in August and accelerated this month has sent the nearest LME contracts spiking to record premiums over copper for later delivery. That’s particularly painful for copper fabricators -- companies that turn basic metal into things like wires, plates and tubes, and who tend to sell LME futures to hedge their price exposure.

But the emptying warehouses have also helped drive benchmark prices toward record levels and copper’s pervasive role in the world means that the jump in costs will add to wide-reaching inflationary pressure for manufacturers and builders. And while mounting threats to global economic activity are raising questions about the outlook for copper demand, inventories on Chinese and U.S. rivals to the LME are also low.

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Only a small fraction of the world’s copper ever enters an LME warehouse, and copper users tend to have long-term contracts with producers and traders rather than seeking supplies from the exchange. Nonetheless, the fact that exchange stocks are so low -- and not just on the LME -- shows that the market’s buffer has worn dangerously thin.

The LME brought in emergency measures on Tuesday evening to address the situation. Among them was a temporary change in rules allowing anyone with a short position who is unable to deliver copper to defer their delivery obligation for a fee.

“This is an unprecedented situation, and we haven’t seen anything like this in the recent history of the copper market,” said Robin Bhar, an independent consultant who’s been analyzing the LME metals markets for more than 35 years. “These market actions are draconian, but they are needed.”

The LME has also started an inquiry, asking banks and brokers for information on their and their clients’ activity in the copper market over the past two months. Trading house Trafigura Group withdrew a significant proportion of the copper that’s been pulled from LME warehouses in recent months, Bloomberg reported Tuesday.

Trafigura responded by saying it had taken LME stocks to deliver to end users, emphasizing there’s strong copper demand that is outstripping available supply. “Trafigura’s role is to ensure security of supply of commodities for its customers,” a spokesperson for the trading house said.

Source: Waupaca Foundry