March 3, 2020 / 4:34 PM / a month ago

Column: Do LME stock movements still matter? The robots think so

LONDON (Reuters) - Do London Metal Exchange (LME) stock movements have any market significance?

Traders work on the floor of the London Metal Exchange, in London, Britain September 27, 2018. REUTERS/Simon Dawson

There was a distant time when everyone thought so. The LME’s daily stocks report was eagerly awaited for the light it shone on what was happening in the “real” physical metal markets.

If the report contained a surprise, such as a major delivery onto LME warrant, the market was collectively swift to price in the information.

That perceived relationship between LME stocks and metal prices, however, has been steadily eroded over the years as the market has learnt that movements of metal on and off exchange are more likely to be down to storage than market drivers.

The growth of a shadow LME storage network has further blurred any direct read-through from stock movements to underlying physical market dynamics.

Just occasionally, however, the LME’s daily stocks report does still generate a significant price response.

Such was the case last Wednesday, Feb. 26, when the report showed 62,325 tonnes of copper “arrivals”.

It was the largest single-day delivery of copper on record so the slide in the copper price after the report’s release was not entirely surprising.

However, the speed of the price reaction says a lot about who is still really paying attention to LME stocks. And it isn’t us humans.

“ARRIVAL” EVENTS

The “arrival” of so much metal in the LME warehouse system over the course of a single day wouldn’t phase your average aluminium trader, given a long history of mega-tonnage movement in that market.

However, it was a record for copper, although not without precedent.

In fact, such copper “arrival events” have become ever more frequent over the last couple of years, large tonnages of metal turning up in the LME warehouse system over a concentrated time frame. An even larger tonnage, 74,475 tonnes, was warranted over the course of just two days in January.

These are not really “arrivals” in the true sense of the word. Such significant tonnages of metal don’t just turn up at port, get unloaded, placed into an LME warehouse and warranted in a 24-hour period.

Particularly when the inflow is split across several locations as was the case with last week’s copper deliveries. Metal hit the system in sizeable quantities at New Orleans (20,000 tonnes), Kaohsiung in Taiwan (12,675 tonnes), Busan in South Korea (16,675 tonnes) and Rotterdam (9,450 tonnes)

Rather, this is metal that was already sitting in an LME shed or at least in very close proximity. The “arrival” occurs when the owner presses the computer button to place the metal on LME warrant.

And the owner in this case evidently coordinated the warranting to achieve maximum market impact.

PRICE IMPACT

And whoever was behind the inflow did indeed make an impact.

It’s not evident from a daily chart, which shows LME three-month copper opening and closing the day at the same price of $5,670 per tonne.

Indeed, in the rear-view chart picture the day’s trading activity looks no more than a pause in a mini downtrend that saw copper slide from a Feb. 17 high of $5,828 to a Feb. 28 low of $5,533 as fears over the coronavirus spread.

However, the real action played out over a much shorter period of time.

Within a minute of the stocks report release copper had fallen by $18 per tonne with volumes on the LME’s Select electronic platform spiking to 555 lots.

Even that, however, doesn’t capture the full speed of the price reaction.

The stocks report was released on Refinitiv screens at 09.00.16 on that particular day and within the following second 89 lots (2,225 tonnes) traded with the price skidding from $5,666 to $5,658 per tonne.

There were clusters of trades timed around specific nanoseconds such as the 11 lots that changed hands at 09.00.17.690 and the 15 lots at 0900.17.720.

These, remember, are completed trades. The interplay of bid and offer was happening at sub-nanosecond speed, a sure sign that high-frequency trading programmes were the protagonists behind the price move.

The robots, in other words, were trading the stocks report within the time it would have taken a human mind to do a fast double-take on the size of the copper inflow that day.

SUPER-FAST BUT BEHIND THE CURVE

The price reaction to last Wednesday’s stocks surge underlines the extent to which robots have been programmed to respond to unusual LME stock movements.

This is not in itself surprising since robots feed on data and the LME stocks report provides one of the few daily hard data points in the base metals trading universe.

However, it does pose some interesting questions as to what is the definition of a tradeable stocks movement.

Obviously, 62,325 tonnes of arrivals, generating a net stocks increase of 61,175 tonnes is hardly a normal daily occurrence.

But in the context of the copper market over the last years it’s not a black swan event either. There have been over 20 incidences of outsized copper arrivals in the LME warehouse system since the middle of 2016. Several of them have been bigger, albeit extended over two or three days.

Ask a human copper trader and the chances are that they will shrug and point to the long-running battle between two major copper players with differing views of the market. One throws metal into the system, the other cancels it and takes it out again.

The “arrival” of so much metal may indeed say something about the state of the underlying market but the message has been massaged by the entity delivering the metal.

In the case of aluminium, it’s the gaming of warehouse incentives that generates much of the visible stocks movements in the LME system. What comes in and goes out says little of value about the state of the aluminium market other than that there’s a lot of metal out there. Which we all know.

This is why many human metals traders have grown sceptical that LME stock movements actually mean anything.

How ironic then that the robots have yet to learn the ambiguities of the LME storage system, treating each unusual data point as a meaningful price signal.

Sure they can react faster, but they’re around 10 years behind the curve in terms of what they’re reacting to.

The opinions expressed here are those of the author, a columnist for Reuters. 

Editing by Jane Merriman

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