How traders get around the rules

London: Keeping one step ahead of regulators, traders are again putting the squeeze on metals markets.

Some have found new ways of employing the time-honoured technique of forcing prices higher by building up stockpiles of metals to make a killing in distorted markets.

Regulators at the London Metal Exchange had tried to stop the practice after a trader with Sumitomo Corp was found in 1996 to have been controlling five per cent of the world's yearly supply of the red metal for a decade.

They have since fine-tuned rules to deny "dominant holders" — defined as those controlling over half of stocks in any metal and cash positions — from profiting from that position. They are instead forced to give their metal away at scant profit.

Fine line

But now some traders are suspected of shifting millions of tonnes of stocks around the world and taking some tonnages off warrant at the LME to ensure their positions, or holdings, meet regulators' requirements while cornering the market. Often they own the warehouses storing the metal which helps the operation.

"It's a fine line. Increasingly operators are a lot more sophisticated in how they keep on the right side [of market abuse regulations]," said analyst Robin Bhar at Societe Generale in London.

But as bidders circle around the LME — due to accept binding takeover offers Monday — the exchange may have to tackle questions over its rules to guard against market abuse and its transparency of market data.

Traders say the market for copper — a metal widely used in power generation, construction and the auto sector — is being squeezed. Copper prices flipped into backwardation in early March, making prices for the metal now more expensive than those for future delivery, indicating a severe supply shortage. Many of those interviewed say commodity house Glencore has amassed a dominant position on the LME in copper.

Glencore declined to comment.

Some LME users are calling for a deep look at the interaction between long delays in accessing metal in warehouses, financing deals, warehouse ownership and dominant positions.

"The LME and maybe the market as a whole needs to revisit this ... It's not a perfect system and it's come in for a lot of criticism and anger. It's worth opening it up for some intelligent responses," said Bhar.

Others say that the building blocks of potentially severe squeezes are now being put into place.

"It's potentially very, very interesting and the ramifications in a year or two could be quite extraordinary when demand really kicks in," said analyst Wiktor Bielski at VTB Capital.

Tactics

LME stocks have fallen by almost half since last October to the lowest levels in over three years, while stocks at bonded warehouses in Shanghai are estimated to have more than doubled to as much as 650,000 tonnes.

At the same time, over a third of LME copper stocks, more than half at US warehouses, are waiting to be removed and are not available to the market, sparking fears that some of the moves are tactics to squeeze the market.

"The drawdown in LME stocks in the US may partly represent large traders moving metal off warrant to exacerbate the tightness and prepare the ground for a major squeeze later in the year, when Chinese buying is likely to accelerate again," Bielski said. Warrants are ownership documents for LME stocks.

LME data showed one party had control of over half of the combined LME stocks and cash positions, giving it a dominant position. The position at one point soared to over 90 per cent.

Traders use old technique to squeeze metals market

London: While LME rules put a lid on profits that can be earned on expiring cash positions, traders have several ways of spinning profits from holding major positions.

One strategy is to keep prices and premiums buoyant for spot business executed outside the exchange.

"Even though we didn't make any money from [LME requirements on] lending, we more than made up for it from our physicals business," said a trader whose firm held a dominant position last year.

Trade houses such as Glencore have long had an advantage in the metals markets due to their extensive intelligence about physical markets and big banks have mimicked that model, expanding operations in physical metals trading and warehouses.

The link between inventories and large positions is now in focus in the copper market, where cash premiums over three-month futures jumped in recent weeks to the highest levels in three-and-a-half years and the nearby "tom/next" spread also surged.

In this case, the tight conditions are localised on the LME due to a global imbalance in stocks, the perfect environment for traders to apply pressure points.