LONDON Nov 4 The London Metal Exchange's
proposals to cut queues to get metal out of the warehouses could
increase price volatility and reduce transparency as more metal
moves off the exchange, Goldman Sachs said in a research
The LME, the world's largest metals marketplace, has come
under regulatory and legal scrutiny over its metal storage
practices, with complaints about months-long queues to withdraw
physical metal from its warehouses.
Clients of the warehouses say the system inflates the cost,
or premium, to secure metal. This is particularly so for
aluminium, which is used in packaging and transport, even though
the market is in global oversupply.
In July, the LME proposed new rules to overhaul the
delivery system from next April that would force warehouses to
release more stocks once the wait-time breaches 100 days.
The exchange, acquired by Hong Kong Exchanges and Clearing
last year, said last month it had made a decision on
its proposal, and would reveal details at a later date.
Goldman, which owns metals warehousing firm Metro but has
Chinese Walls between its research, banking divisions and
warehousing operations, said premium volatility had indeed
increased the cost of using the LME as a hedge against physical
"Clearly, should these costs increase, the demand for the
LME as a hedging tool against physical price risk may decline,"
"But going too far in the other direction in managing this
basis (premium) risk may also impact the economic role of the
exchange market - reducing transparency, liquidity and impacting
the ability of the LME to create a buyer of first resort and
seller of last restort."
To support the mechanism of physical delivery of its futures
contracts the LME approves and licenses a network of around 700
warehouses across 36 locations around the world.
"Increasing the load-out rate potentially lowers
transparency and increased LME rents and delivery-out charges as
warehouses attempt to recoup the costs of investing in
additional capacity to load out," Goldman Sachs said.
And limiting the load-in rate reduces the LME's ability to
create a market of last resort in times of surplus, it said.
"We find that 'managing' the queue by the LME could have
significant direct costs in the proper functioning of the
exchange which can increase price volatility and indirect social
costs by reducing transparency as more metal moves off
exchange," it said.
LME warehouses hold 5.4 million tonnes of aluminium, but it
is concentrated in only two locations: Detroit, where Goldman's
Metro dominates, and Vlissingen in the Netherlands,
Glencore-Xstrata's Pacorini stronghold.
Metal buyers' complaints have resulted in U.S.-based
lawsuits by consumers, distributors and others alleging
aluminium price-fixing and anti-competitive behaviour by
investment banks, large trading houses and the LME.
Goldman, a defendant in some of the lawsuits, has dismissed
the lawsuits against them as without merit.