(Bloomberg) — Fund manager Luke Sadrian has been trading metals for thirty years, at hedge fund titans Brevan Howard and Moore Capital to now running his own shop. For the first time in his career, he says the London Metal Exchange is too risky to trade.
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Sadrian, like many market veterans, was shocked by the LME’s decision to suspend nickel trading on Tuesday morning and cancel all the transactions from earlier in the day. Now, in the middle of a scorching bull market that’s lifted prices to record highs, some in the industry are simply deciding to walk away.
“The LME has been my bread and butter for a very long time, so it’s heartbreaking,” said Sadrian, whose Commodities World Capital fund is up about 120% this year. “Given the current uncertainty, I am exiting all of my LME positions, despite being ragingly bullish on copper.”
The LME’s drastic intervention came eight hours into the most volatile day in its modern history, as skyrocketing prices left brokers and clients facing huge margin calls against loss-making positions. Prices more than doubled during Asian trading hours, before the LME suspended the market and said the day’s trades — worth about $3.9 billion according to Bloomberg calculations — would be canceled.
Defending its decisions on Thursday, the exchange said that the spiking prices had created a “systemic risk” to the market, generating margin calls far higher than it had ever seen and raising significant risk of multiple defaults. Chief Executive Officer Matthew Chamberlain said earlier in the week that several dealers would have struggled to survive if the LME hadn’t pulled the plug.
This week’s turmoil was the latest in a string of controversies at the LME, from a u-turn on a plan to close its open-outcry trading floor to a massive squeeze in the copper market that saw its warehouses nearly depleted late last year. Still, the decision to cancel Tuesday’s trades may prove a watershed moment for some of the market’s staunchest supporters.
By voiding the transactions, the LME effectively bailed out bearish position-holders at the expense of their bullish counterparts on the other side of the trade.
What’s more, it caused havoc for traders who had been active in the small hours of Tuesday morning. Some sold long positions at a profit, only to have the sale canceled; some placed relative value bets on nickel versus other metals, only to have the nickel part of the trade canceled; and some banks used the exchange to hedge positions with their clients, only to have the hedges torn up.
“The LME market was open and bona fide users agreed bona fide contracts, they should be able to rely on them,” said David Lilley, a co-founder of the Red Kite metals fund who now runs Drakewood Capital Management. “It is the whole purpose of a regulated exchange.”
Lilley and Sadrian are among an old guard of specialist metals traders who’ve spent their careers honing the idiosyncratic skillset required to prosper on the famously arcane exchange, which is one of the last in the world to still settle prices via a daily open-outcry shouting match, and which runs a global warehousing network that’s a crucial part of the plumbing in physical metals markets.
However, the outrage was not limited to metals specialists, but extended to more generalist fund managers — the very investors that the LME has been trying to court for years in an attempt to boost trading volumes. Cliff Asness, founder of AQR Capital Management, took to Twitter to vent his outrage.
“I’ve been doing this for a wee bit of time,” he said in a tweet. “This is one of the worst things I’ve ever seen.”
To be sure, the anger expressed by some traders is far from universal, and the LME has won praise from others for putting the brakes on an unprecedented price spike that left nickel consumers such as steel mills reeling.
Many physical users of the bourse also rely on its boutique brokers to provide credit to hedge their price risks, and if any had failed the ripple effects through the physical industry could have been severe.
The LME has itself pledged to put the interests of its core users first in its strategic decision-making, above those of the hedge funds, algorithmic traders and banks that also populate its ecosystem.
“I think the exchange was absolutely right to halt trading, in fact I think they should have done it earlier,” said Mark Hansen, CEO of physical commodities trader Concord Resources Ltd. “Everyone has a stake in an orderly, functioning market, and we’ve already seen as a result of this move in nickel that consumers are closing steel plants or liquidating inventories.”
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