London Metals Chief's bubble justification backfires

By Neil Behrmann


October 2008:- The implosion of the commodities bubble confirms that excessive speculation and so called "investment demand" pushed raw materials prices to ludicrous levels. Speculation is neccessary in any market to provide liquidity but in the past few years hedge fund and pension fund inflows and unofficial producer cartels have effectively hijacked commodities markets.  They range from energy to metals, wheat, corn and other markets. Manipulation and price ramping, so far unproven, have been alleged. These price surges, especially energy, have been behind the raw materials inflation that has discouraged central banks, e.g. the ECB from cutting interest rates during the credit crisis. High raw materials and food prices have hurt businesses and the poor and the subsequent inflation has delayed the reflation necessary to limit the extent and duration of recession.

Exchanges could easily have raised margins substantially to curb speculation (see BLOG - Fund & index speculation wreck commodity markets & cause misery - Debate).

The London Metal Exchange, as an example, should have learnt its lesson from the collapse of the tin market in the mid eighties and the $3 billion Yasuo Hamanaka of Sumitomo copper fraud in 1996. Unfortunately, once again the exchange allowed the market to get out of hand. Metal prices soared above expectations e.g. nickel rocketed to more than $50,000 a metric ton in 2007 from around $6400 in the autumn of 2002 and has since fallen to $14,500.

Judge for yourself.

Bloomberg interviewed Martin Abbot chief executive of the London Metal Exchange on June 25 this year.  The copper price, for example, was then $8,350 a metric, slightly below its its peak of $8,880, compared with $1500 in 2003. In tandem with other metals and commodities, copper has since tumbled by  more than a third to $5,250.

Here follows the nub of Bloomberg's interview with Abbot and the response of Resolve Inc's David Threlkeld, a long experienced metals trader who warned about the Hamanaka fraud, several years before the exposure and market collapse.

The Bloomberg article

June 25, 2008 (Bloomberg) -- Governments would be ``foolish'' to limit participation in commodity markets and curb speculation because prices are based on supply and demand, London Metal Exchange Chief Executive Officer Martin Abbott said.

Rising demand from emerging markets and a lack of investment by suppliers have created a ``structural change'' in commodity markets, fueling higher prices, Abbott said yesterday in an interview in New York. Increasing regulation to limit speculative interest won't lower prices and may hamper the market's role in price discovery, he said.

``There is in the commodity space as a whole something going on which cannot be ascribed to simply hot money coming through exchanges,'' said Abbott, who heads the world's largest marketplace for copper, aluminum and other base metals. ``It would be very foolish of any government to stifle participation in markets.''

Surging prices for commodities such as crude oil, corn and copper have prompted US Senator Joseph Lieberman to suggest more regulation is needed to limit the role of speculators in the markets. Billionaire investor George Soros has labeled the jump in energy prices a speculative bubble.

``Why would an elected politician have a better idea of what the price is than the summation of the entire world's oil industry trading across an open exchange?'' Abbott said. ``For a government to try and determine a good price for something is nonsense.''

``We didn't invest in plants, we didn't invest in deposits, and there's no wonder that the markets have caught up,'' Abbott said. ``What's going on here is a structural change.''

``Without speculators markets don't work,'' Abbott said. ``The world economy is not going to function without the free flow of cash, and the free flow of cash is not possible without the free interaction of markets.''

David Threlkeld of Resolved wrote an open letter to Abbot at the beginning of July, when oil and commoditiy indices peaked.

Dear Mr. Abbott,


I am writing to you concerning the comments you made in an interview with
Bloomberg on June 25th. As the Chief Executive of the London Metal Exchange (LME), the worlds largest metals market, the opinions you publicly express are widely circulated and are very influential in decisions made in the industrial and financial sectors. I was somewhat surprised that during these unprecedented times of runaway commodity prices and accusations of market distortions that you did not use the interview as an opportunity to inform the world of what the LME was doing to insure orderly and honest trading.

As a user of the LME and a free market advocate I have a great deal of trouble agreeing with your arguments and justification for current prices, especially copper. I will address my concerns in the order Bloomberg published them.

Governments would be ``foolish'' to limit participation in commodity
markets and curb speculation because prices are based on supply and
demand, London Metal Exchange Chief Executive Officer Martin Abbott said.


Politicians have threatened to introduce legislation to curb commodity speculation because they do not believe that prices are
fundamentally justified and have not been reassured by the exchanges that this is in fact the case.

“Rising demand from emerging markets and a lack of investment by
suppliers have created a ``structural change'' in commodity markets, fueling
higher prices, Abbott said

In the current global economic slow down it would be fundamentally reasonable to assume that consumption has gone down and prices have weakened. This indeed is the case for lead, zinc and nickel. Copper on the other hand has remained stubbornly resilient and is in striking distance of its previous all time high despite the increasingly bearish fundamentals.
In 2007 world refined copper production substantially exceeded consumption by at least 750,000 tons. The inventory overhang in China has caused its prices to be at substantial discount to the rest of the world. In the first quarter of this year the International copper Study Group has reported that global consumption is down by nearly 1%.  First quarter average mine capacity utilization was slashed to 81%. This is a fundamental picture of slowing consumption, unreported copper inventories and producers reducing production in face or worsening consumption.

``There is no way that any speculator wants to be the person driving the market,'' said Abbott. ``Anyone can think of a strategy that would drive a market, but not many people have managed to think of a strategy that would get them out of that strategy with a profit. That's one of the things that keeps markets safe.''

Speculators in metals have in the past attempted on numerous occasions to drive markets and in the end have invariably resorted to manipulative practices as to try and exit the position. Yasuo Hamanaka of Sumitomo, was able to operate a manipulative scheme for over 5 years without detection. It has happened before and there is absolutely no reason why it could not happen again.

``We didn't invest in plants, we didn't invest in deposits, and there's no wonder that the markets have caught up,'' Abbott said. ``What's going on here is a structural change.''`

A substantial investment has been made in mining, smelting and refining which guarantees more than adequate supplies in the future. According to ISCG, between 2006 and 2011 world mine capacity will grow from 17m tons to 22m tons, smelter production will go from16.3m tons to18.8m tons and refinery production will increase from 20.6m ton to 25.2m tons.  If neither speculative, investment nor fundamentals reasons are driving prices, could it be that manipulation has returned from its decade long sabbatical?

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