* Tom/next aluminium volumes fell 50 pct in Jan 2015
* Metals a sideshow for funds this year, oil more lucrative
* 20-50 percent of metals trading activity estimated to be OTC
* Monthly tom/next LME aluminium volumes: reut.rs/1WcvtOy
* LME volumes 2000-2016: tmsnrt.rs/1V7pJ7w
By Pratima Desai
LONDON, May 24 (Reuters) - Core industrial clients of the London Metal Exchange (LME), unhappy with a steep rise in trading fees, are taking some of their business to top-tier investment banks and rival exchanges, industry sources said.
Business moving to banks and in some cases, the CME group , is reflected by a 4 percent drop in volumes on the 139-year old exchange last year, the first annual fall since 2009.
Turnover in the first four months of 2016 has dropped more than 9 percent from the same period last year.
Sources blame the exodus on an eye-watering 31 percent average fee hike designed to boost profits for the exchange's new owner, Hong Kong Exchanges and Clearing Ltd, which bought the LME for $2.2 billion in 2012.
The collapse of Lehman Brothers in 2008 and broker MF Global in 2011 meant that for some years after over-the-counter (OTC) trade had been shunned by many seeking safety on exchanges and centralised clearing houses.
But the physical market -- consumers and producers -- has rethought that premise. OTC business in metals is rising, with estimates now ranging between 20 and 50 percent of total metals trading activity, sources say.
"If you choose your counterparty carefully, banks that still have investment grade rating, OTC is not going to be a problem," a commodity trading source said. "More business is going OTC to avoid the fees."
U.S. banks JPMorgan and Goldman Sachs are two banks which kept their investment grade rating after the 2008 financial crisis. Both banks declined to comment.
"Trading costs on the LME are now exorbitant. I'm surprised they haven't cut the fees yet, the damage is obvious. We avoid the LME where possible," a source at a copper consumer said.
A major hit to LME volumes comes from deals up to and within 14 days, which before January 2015 were not subject to fees. One very popular trade in this category used to be tom/next -- buying tomorrow and selling the day after.
But not any more. Tom/next volumes for aluminium CMALT-0 slumped an annual 50 percent in January 2015 when the higher fees were introduced. So far this month they are on track for a more than 40 percent annual drop.
"The LME is eroding its core client base in the physical market," said Malcolm Freeman, chief executive at Kingdom Futures. "The CME is picking up volumes."
LME volumes are still a large multiple of those for metals on the CME, but sources say recent gains on the U.S. exchange are noteworthy. Copper volumes on the CME jumped an annual 16 percent in the first four months of 2016, while on the LME they fell nearly 13 percent.
A copper consumer wanting to buy 100,000 tonnes of copper through a LME member could pay up to $10,080 in trading costs if all the fees are passed on. The costs of trading for a consumer on the CME for the same amount of copper are nearly $6,200.
Part of the problem for the LME this year has been subdued volatility.
"Base metals compared to other commodities have been a bit dull in terms of volatility," a broking source said."
"Oil has been more profitable for funds and metals have been a sideshow," the broking source said.
Benchmark copper touched $4,318 a tonne on January 15, its lowest since May 2009, but since then daily moves have mostly ranged between a gain of 3.5 percent and losses of 2.8 percent compared with 11 percent and 7.8 percent respectively for Brent oil.
"The LME sees substantial trading volumes across the entire base metals market, not just copper. These volumes naturally fluctuate for many reasons, including macroeconomic factors," an LME spokeswoman said.
"Historically low prices have led to lower hedging activity from the physical industry, which is a significant constituency of the LME market."
Reporting by Pratima Desai; Editing by Veronica Brown and Louise Heavens