Thursday, 21 April 2011

Fun things to do in London’s Financial heartland No.1: Going on Exchange

Last week I took a London-based NGO to the London Metal Exchange. We’re kind of concerned about some issues around commodity speculation, so thought it would be worth a visit. To be fair, I sometimes go with my friend Harry just for fun, because it’s such a darn unique curiosity. If you ever want to do it, go to the LME website, fill in the booking form and send it to them.

Why would you want to go there? Because it’s the largest global exchange in industrial metals, and that makes it an interesting node in the matrix of global trade. It mostly deals with metal derivatives (futures and options contracts for future delivery of metal), but trade in physical metals for immediate delivery also occurs. I spoke to a trader outside when he was having a smoke, and he said that if you deal in the physical ‘spot’ contracts, you’ll have metal waiting for you in a warehouse within two days.

The real choice is what metal you want. There’s no useless precious metal here, it’s all useful base metals, the physical underpinnings of global industrialisation and urbanisation. Most important is copper, used in electronics and construction. Its price is a key proxy for world economic growth, especially of developing countries. Chilean mines are the largest suppliers, and Chinese companies are the largest consumers. We churn through some 50 000 tonnes of this stuff each day.

Second up is aluminum, used for cars and construction and tin foil. Then there’s zinc, mostly used for galvanising steel for the auto and construction industries. Nickel gets used in the creation of stainless steel, and batteries for hybrid cars. Normal car batteries get made out of lead, half of which is mined in China. Rechargeable batteries for mobile phones get made with cobalt, mostly produced in the Democratic Republic of the Congo, but then shipped to China. Other metals include tin, dominated by only four producing countries – China, Indonesia, Peru and Malaysia – and molybdenum, a rare earth used in steel alloys.

Every metal on the exchange is pretty much dominated by China in terms of global consumption, and, frequently, production. It thus seems something of a historical anachronism that the exchange is in London rather than Shanghai. Then again, it’s an open question about how much of the LME trade is actually related to physical metals for real-world use, and how much is purely related to the speculative activities of London-based investors.

So let’s say a hedge fund decides that things in the DRC aren’t looking favourable. They phone their local broker at the office, and request to purchase 100 cobalt futures. The broker at the office phones his floor broker on the exchange, who gives the order to the clerk. The clerk gives the order to a guy sitting on a plush red leather couch in the ring. This is the ring dealer. The ring dealer casually shouts that they want to buy 100 cobalt futures. Some other ring dealer, carrying a different order, casually agrees to sell. Deal done. The clerk relays the info back, and the phone rings at the hedge fund office, telling them that the trade is done. They now own 100 tonnes of cobalt, in a roundabout way, through the derivative.

And this kind of thing goes on all day, and the prices set in the process become the ‘official’ price of cobalt around the world, used as a benchmark for producers and users to set their own prices.

For the most excitement, you probably want to go for the ‘kerb trading’ sessions, the afternoon free-for-all where they shout at each other. The earlier sessions are kind of boring and the ring dealers just sit around and don’t seem that interested in setting the global price of metal. Keep a look out while you’re there for moments of intrigue: See if you can spot JP Morgan trying to corner the copper market.

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