Retired metal merchant, Anthony Lipmann, illuminates trading for the young entering the world of metals.
Last night I dreamt I was short of …ium – a metal we source from Russia.
As with my worst dreams, this one involved a commitment to do something I was unable to perform. A recurring bad dream I have is to be cast in a play and not know my lines. My actor cousin in Poland tells me this means I am a closet actor.
In this mundane metal dream, I broke my minor metal trading rule by going short – entering a contract to sell something I did not have in stock.
…ium is not an exciting minor metal. It is a tradeable element, but not one important enough for bigger companies to take note of, and not of sufficient margin or volume. It is plentiful in nature but the pure form of it is rare.
I made my sale (in the dream, you understand) and the next day Russia invaded Ukraine.
In the metal trade we have many rules we invent and break. Not to leave an offer firm over a holiday period (allowing unexpected events to occur which might affect price). Not to sell material of a specification that does not match the quality in stock (even small deviations in trace elements can make goods unsaleable and put you short.) But above all, in unhedgeable minor metals, to not sell that which you do not have.
The younger trader might rightly feel there are events that rarely happen. Invasions, for example. Specifically, they might not have been hyper-aware of the potential for the invasion of Ukraine on Feb 24th 2022, which made Russia a pariah state for many of its trading partners.
In my dream and, as it happened, in reality, we sourced …ium from Russia because no other entity produced it in the form our customers are happy with.
In my mental picture (which is now my worst trading nightmare) I am short to a good customer. I want to declare ‘force majeure’ but as I have not entered a contract to buy the material (the …ium) there is no identifiable lot for which I am being let down. The firm of lawyers Osborne Clarke puts it like this1:
It is… insufficient to abstractly claim the existence of the war in Ukraine to trigger the application of a force majeure clause. Instead, it is generally necessary to assess the impact of the conflict on a specific contractual relation by identifying, for each particular case, which factors are effectively and directly preventing the performance of the obligations derived from the contract.
The younger person entering the metal trade in a (presently) safe European country may know little of war until it actually happens. The effect of it in far off lands may not be immediate enough to cause alarm and instil caution. Instead, the primary aim of the young trader is just to make a profit, make a splash, and perhaps tell his or her mates about it at the pub.
Going short might seem theoretical. But think of the situation that was created on the London Metal Exchange as a result of the same event – the day nickel rose tenfold to $100,000 /t and created havoc for the shorts before a market intervention that is likely to be a subject of legal disputes for decades.
Anyone – any young person entering the metal trade – if they wish to progress – needs to know viscerally that these so called ‘once in a lifetime’ events do sometimes happen, and they are misnamed.
In a lifetime, there are multiple such events. That they happen half a world away while we are not paying attention, is no defence and no help when they do. In the early 1980s, many dealers were short when US helicopters crashed in Iran during the hostage crisis. Copper rose and fell by £100 per tonne on a single day, creating havoc.
In more recent memory, you need to look no further than a Chinese company who had hedged their nickel on the LME and was caught when the metal’s price spiked in response to the invasion of Ukraine. These events do not spring up randomly, they have their causes and effects – though we do not always have enough world experience to expect them. And the effect on supply and prices is certainly not random. These causes and effects are simply ignored when clever people (too clever) come up with potentially profitable deals that later unravel.
Speaking of clever people, there is a famous quote:
“In theory, there is no difference between theory and practice. In practice, there is.”
This can be applied to the difference between futures hedging on a commodity exchange and the practicalities of the physical market.
An example of what we could call “false hedging” is when a trader sells nickel or copper on LME against a physical product which might contain Ni or Cu but whose physical characteristics differ from exchange-deliverable metal form, and whose price may diverge completely.
For example, the LME can rise sharply on events while the physical product may not reflect this in price. In essence, the trader has put themselves short with false confidence in an unworkable hedge. In theory they have mitigated a risk, in practice, they have not.
It is hard to explain to the eager young metal merchant the need to hold back, the ultra-conservatism which we try to employ. But think of it this way – our caution is what makes us reliable. It’s the fact that we do not sell what we did not own, that means our customers have confidence in us. No further explaining is needed.
After decades of trying to be reliable, our customers often trust us as a trader more than a producer. The producer, you see, can so easily declare ‘force majeure’ on their sales contracts, while the trader in most instances cannot.
In the case of my all-too-real dream, I woke up disturbed and sweating, and drank a cup of coffee.
The bit that wasn’t a dream was the invasion of Ukraine – and his nightmare looks as if it will continue for a very long time (and I think we all need to feel it – viscerally).
By Anthony Lipmann