The London Metal Exchange (LME) has just seen its biggest ever price move: the price of nickel has jumped by as much as 250% from the start of this week.
The LME has now suspended trading as it tries to restore a bit of order to the market.
What’s going on? And does it matter for you?
Nickel’s dizzying ride
The nickel price shot above $100,000 a ton this morning. For perspective, on Friday it was trading at $30,000 a ton, and that was the highest level since 2008.
That’s getting on for being cryptocurrency levels of volatility. So what happened? It’s all connected to Russian sanctions, which have triggered what’s known as a “short squeeze”.
In the stockmarket, investors short sell a stock if they think it is going to fall in value. To do this, they borrow the stock from someone else, sell it in the market, then hope to buy it back later at a lower price. They then return it to the lender, and pocket the profit.
This is risky even at the best of times. A stock can only fall to zero, but there is no limit to how high it can go. But it’s incredibly risky if lots of people have the same view as you. If lots of people have borrowed stock to sell, and thus need to buy it back at some point, that creates conditions for a buying panic.
If the stock does something unexpected – a big buyer comes along, or it reports results or even forecasts that beat expectations – the price might move sharply higher. As those with short positions rush to cover their positions (in other words, buying stock in the open market to return to the lenders), they push the price even higher.
That kicks people out of existing positions as their brokers demand more margin. That pushes the price even higher, and so on.
Hence the term “short squeeze”. Very painful to be on the end of one.
In the commodities market, though, things work a bit differently. Most of those who are “short” nickel aren’t doing it to bet on the nickel price falling. They’re doing it to hedge their production of the metal.
In the stockmarket, if you’ve got a big portfolio but you’re worried about prices falling, you might take out a short position to hedge against that fear. It’s an insurance policy rather than a bet; it’ll pay out if prices fall, but you don’t want them too.
It’s sort-of similar with commodities production. If you produce nickel, you’re going to have a lot of physical metal. You are “long” nickel. The tricky thing is that prices move around a lot. To give yourself some protection from falling prices, you might go short in the market. You’d calculate this in such a way that moves in one offset moves in the other.
But if something surprising happens then prices might move a lot more aggressively than you expect. As a result, you end up getting margin calls (you get asked to put up more money to cover your position) and if you can’t do it, well, the position gets shut down, which pushes the price higher.
Russia has pulled the rug out from under the commodities sector
Of course, something surprising just happened. It’s important not to forget that metals prices were already rising, partly because of pandemic disruption and partly because we were coming out of a big bear market in resources. Nickel supplies in particular were tight already, as it’s a key ingredient in the hoped-for electric vehicle revolution.
But we’ve now thrown in the problem that Russia is a major supplier of nickel – it produces 17% of the global supply of the top-grade nickel, not to mention lots of other commodities. That’s really pulled the rug under from lots of markets.
In this case, Tsingshan Holding Group, which is the world’s largest nickel and stainless steel producer, apparently held a big hedging short position. Via Bloomberg we hear that “a unit of China construction Bank Corp, which is one of Tsinghan’s brokers, was given additional time by the LME to pay hundreds of millions of dollars of margin calls it missed Monday.”
So what happens now? In terms of actual supply of the metal, the classic story with commodities is that high prices cure high prices, as more supply is brought online. As David Fickling of Bloomberg points out, nickel is not scarce, so you’d expect to see supply rise if these sorts of prices last for long.
What’s perhaps a little more concerning is the possibility of financial market disruption. There are a lot of bits of financing involved in the commodities trade. Requirements for credit at all of these points in the chain are exploding higher. What effect does all of this have on the financial plumbing?
I’m sure we’ll find out soon enough. Unless you’re a leveraged day trader (bad idea) you probably don’t need to worry too much. But even long-term investors should keep an eye on the companies in their portfolios and watch out for nasty surprises related to hitherto-unexpected derivatives exposure.