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The London Metal Exchange announced recently that trading volumes on the bourse have reached record highs. The LME said record volumes were transacted in May, beating the previous all-time high from April. Aluminium volumes were up 7 per cent, copper was up 10 per cent, zinc by 13 per cent, nickel 19 per cent, and cobalt trading volumes were up a whopping 30 per cent compared to May 2012.
The record trading volume on the LME is a very encouraging sign, particularly as we look to implement plans to further grow the business in Asia and globally. But it also begs the question: what drives the LME’s trading volumes? And why are volumes rising when commodity prices are falling?
First, the factors driving trading volume on the LME have evolved over time. Metal companies have always used the LME to manage volatility. Forward sales on the basis of a fixed price – the traditional contract type – involve the risk of prices moving before delivery, and hence need to be hedged. In fact, that was the principal reason that drove the founding of the LME 135 years ago. Many companies negotiating today agree that the delivery price will be the LME cash average for the month of delivery, for example. As neither party knows today what that price will be, they hedge to avoid disadvantageous price movements; and they hedge via LME contracts. Increasing regulatory pressure alongside pressure from banks and shareholders to reduce credit risk has resulted in further pushes to hedge using LME contracts. We believe there is plenty of room for further growth in this area.
For other players, metals have always been seen as a possible hedge against inflation. And with interest rates low, metals have offered the possibility of an additional return. They have also been seen as a China and BRICS play, as developing countries consume metal for infrastructure and manufacturing.
In addition, electronic trading is playing a bigger role in boosting volumes. Growth in electronic trading on the LME Select system now accounts for a larger share of total volume on the LME.
All these factors have contributed to the long-term growth in volumes on the LME in recent years. Volumes have been rising even more lately because of the volatility of commodity prices.
Yes, that’s right – despite the recent fall in commodity prices, volumes on the LME are actually rising. This may not be straightforward for those used to the equity market, but the impact of falling metal prices on the LME is not the same as that of falling stock prices in the equity market. Let me explain.
In the equity market, daily turnover is largely driven by market sentiment; for instance, if the market turns bearish it may result in fewer people wanting to invest and thus lower turnover. Metal trading on the LME works differently, however. Here, if traders and investors believe the price is too high they sell futures, anticipating lower prices. If they think the price is too low, they buy. This means that as the price of LME metals rise and fall, new business is always being attracted to the exchange. In addition, volatile conditions mean that companies involved in producing, shipping and manufacturing will feel a greater need to hedge using LME futures contracts because their price risk goes up. This is one of the key factors that has led to an increase in volumes.
The most exciting thing about the LME’s record high volumes is that we’re just getting started with our plans for the exchange. Our long-term goal is to further commercialise the business, introduce new members from Asia, launch new products, and build our own clearing platform. As we execute our plans step by step, the full potential of the LME is yet to be unleashed.
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