LME: The Aftermath
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News
LME Update: It’s now been over three weeks since the London Metal Exchange froze its nickel market after a historic short squeeze threatened to blow up a number of brokers, banks & commodities giants caught overexposed. Updates continue to flood into the public spotlight as the market seeks to recover & investigations uncover new information. I’ll cover the main developments rapid-fire below:
Nickel markets have officially reopened, but volumes have remained extremely low across the London & Shanghai markets as prices continue to whipsaw & hit daily exchange limits. Position reports show a market that remains locked between a few large holders on the long side, including Volkswagen, Glencore & a slew of hedge funds, and Tsignshan & other Chinese producers on the short side. The problems that caused nickel’s short squeeze in the first place have not been resolved.
Tsingshan has reduced its short position in the days following March 8 by as much as 10-20%, but still holds significant exposure after negotiating fresh borrowing terms with lenders.
Open interest is dropping alarmingly fast across LME’s markets, even beyond nickel. OI, an age-old signal of an exchange’s relevance & customer trust, is expected to drop further as disgruntled traders finish unwinding positions and fully back away from the exchange.
Meanwhile, physical nickel continues to leave LME’s warehouses in droves as industrial demand remains high & the Russia-induced supply shock takes hold. Sanctions & shipping disruptions have darkened the outlook for supply resolution as most of the deliverable nickel via LME’s contract - shipped from Russian producers - remains locked in Netherlands storage facilities.
The OTC nickel market, normally priced off the LME contract, remains in gridlock as traders & regulators figure out how to recreate settlement prices on March 8 in the absence of official LME prices during the trading session.
LME has doubled the size of its default fund, adding another $1 billion to its reserves to cover future potential defaults. This capital comes from LME’s member firms, many of which are already facing steep margin calls in the wake of nickel’s price rise even before the March 8 short squeeze. Higher capital requirements add to the woes of LME’s already disgruntled customer base.
I shared my initial thoughts on the LME debacle a couple weeks ago as news was first breaking, you can find that piece here:
Wall Street regulator proposes to expand the definition of broker-dealers: On March 28 the SEC unveiled a set of proposals that would significantly expand the definition of a “dealer”, bringing a wide range of new firms under SEC scrutiny. The standard definition of a dealer is “any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise…”. This is an intentionally broad interpretation of the term that has led to much debate about its practical applications. Until March 28 the term generally applied to banks, market makers & wholesalers who clearly defined themselves as active on both sides of a market or who handled the order flow of other parties. Dealers are required to share consistent information about their activities with the SEC, maintain specific capital requirements & are generally subject to increasing levels of regulation over time. Complying with SEC requirements as a broker-dealer can be quite costly & acts as another natural barrier to entry across US market structure.
The new SEC proposal attempts to bring new types of firms under the dealer definition, including high frequency traders, private funds like pensions & hedge funds, and Communication Protocol Systems (ie DeFi applications). SEC Chair Gary Gensler says this rule “could help level the playing field among firms and enhance the resiliency of our markets”.
I’m not a lawyer or regulatory expert and am not intricately aware of all the downstream impacts this rule change would have on US market structure, but I’m having a hard time seeing how broadening the definition of the term “dealer” would positively impact how our markets work today. What problem is this solving?
I’m generally in favor of holding systemically important institutions to higher regulatory standards given their direct & meaningful connection to the real economy. If JPMorgan Chase takes too much risk & fails, the vast web of counterparties that interact with the bank would be immediately in danger of massive losses or outright failure. JPMorgan cannot be allowed to take such risks & should be subject to strict oversight as a result. If a high frequency trading firm, using no outside money & operating without a trillion dollar balance sheet, takes too much risk & fails, does it take the real economy down with it? I don’t think so. HFT firms & others who’ve skirted the “dealer” label are certainly an important part of today’s markets, but I don’t know if that merits giving Gary Gensler’s SEC more control & influence for its own sake.
I found this comment letter published by SEC Commissioner Hester Pierce very helpful to better understand the proposal & its drawbacks. Commissioner Pierce shares my skepticism about the positive impacts of Gensler’s rule change & poses a number of common-sense questions the proposal doesn’t address. For those interested, I recommend reading Pierce’s note in full.
The purpose of this newsletter is to inform & educate people about the exchange industry in all its forms. A big part of that education is equity research - properly valuing & understanding Wall Street estimates for the public exchange stocks. My latest paid post dives into this subject by building & explaining a financial model for CME Group, populating it with sell-side analyst consensus estimates & examining whether those estimates are reasonable. Premium subscribers get immediate access to this model, my thoughts on the stock, and a deep archive of past market structure research. Sign up below if interested:
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Chart Of The Week
They’re baaaaaack!
GameStop, AMC, Tesla, and other meme stocks have been on the move in recent weeks. Two of the three names have announced stock splits that have been met with roaring memetic applause - Tesla surged +6% & GameStop +20% after their respective decisions were made public.
It may feel stale and overplayed, but meme stocks as an asset class don’t seem to have gone away, nor are they fading from the spotlight anytime soon. The last time these stocks were in the public consciousness, it kicked off a wave of market structure events, debates & ultimate changes that affected all parts of the ecosystem. Investors & spectators across the board would be wise to follow the price action & early narratives surrounding these stocks before they again invade every news outlet & social media platform in existence.
The below chart always gives me pause - one year removed from its first memetic explosion, GameStop still trades miles above its pre-2021 price. If retail burnout hasn’t brought the stock back to Earth by now, who’s to say it won’t re-test the highs that brought about so much controversy & debate in the first place?
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, SPGI, NDAQ and VIRT. I am also long BTC, ETH, LOOKS and SOL.