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COLUMN-How Shanghai trading is changing the physical nickel market: Andy Home
(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, April 28 (Reuters) - Everyone's talking about Chinese speculators.
This year has seen an unprecedented surge of trading volumes and open interest in Chinese markets as institutional and retail investors pour money into commodities.
Both the Shanghai Futures Exchange (ShFE) and the Dalian Exchange are upping margin requirements and transaction fees to try and calm overheating contracts such as steel rebar and iron ore.
The stampede appears to have been halted with both prices and trading activity losing some of their recent froth.
But the current trading frenzy shouldn't distract from the growing global influence of China's domestic commodity exchanges.
In a market such as nickel the dramatic rise of the ShFE is exerting an increasingly powerful gravitational pull on physical units, causing ripples through the global refined metal supply chain.
Graphic on ShFE nickel price, volumes and open interest:
UP, UP AND AWAY
The ShFE launched its nickel contract in March last year, since when volumes and open interest have grown dramatically.
The contract hasn't been totally immune from the cross-commodities feeding frenzy of the last few weeks but activity has been on a fast upwards curve ever since the day of launch.
Volumes already regularly exceed those on the London Metal Exchange (LME), which has dominated wholesale nickel trading for many, many years.
In March, for example, the ShFE contract traded around 10.76 million tonnes for nickel, even factoring in Chinese exchanges' habit of counting both sides of a transaction in their volume figures.
On the LME, where volume figures are inflated by the exchange's complex spread structure, headline activity amounted to 10.50 million tonnes.
The Shanghai nickel contract has also seen a steady build in market open interest, currently just over 707,000 tonnes.
That's still some way short of the LME's 1.96 million tonnes but it's noticeable that the Shanghai nickel contract hasn't seen the wild swings in open interest that have characterised some of the most frothy commodity contracts in China in recent weeks.
The take-away is that although Shanghai nickel may be prone to the same day-trading investment crowd flooding other local markets, its success is founded on bigger, more institutional players who are prepared to hold positions for longer.
Graphic on China's Imports of Russian nickel:
FROM RUSSIA WITH LOVE
Indeed, so quickly did trading activity explode into life that the ShFE nickel contract almost immediately ran into trouble in the form of a squeeze on shorts on the July 2015 contract.
The problem was that there were insufficient stocks of the six Chinese good delivery brands to satisfy short position holders looking to settle their positions with physical metal.
So the exchange allowed the delivery of three brands of Russian nickel produced by Norilsk Nickel.
And in doing so, it altered both flows and stocks of refined nickel around the world.
Because Russian metal has been flooding into China ever since. Imports from Russia jumped from 75,000 tonnes in 2014 to 194,000 tonnes in 2015 and were running at an annualised 295,000 tonnes in the first quarter of 2016.
Chinese imports of refined nickel have always included some Russian material but this typically accounted for between 45-55 percent of the total.
That ratio jumped to 64 percent last year and further to 68 percent in the first quarter of this year and that in the context of sharply higher overall import volumes.
Some of that metal has gone into ShFE-registered warehouses, where stocks have been trending ever higher. They currently stand at just over 80,000 tonnes.
More has disappeared into off-market obscurity. David Wilson (Oslo: WILS.OL - news) , analyst at Citi, estimates that there is somewhere like 250,000-300,000 tonnes of metal in bonded warehouse and mainland non-exchange storage. ("Nickel - More Funds than Fundamentals", April 26, 2016)
Much of it is tied into one form or another of financing deal. This is nothing new. Nickel has long been a favoured collateral commodity because of its relatively high value.
But it's a moot question as to whether a local exchange delivery option has given the financing business an extra fillip by affording lenders on the mainland an added level of security.
Graphic on LME nickel stocks: http://tmsnrt.rs/1NCvVCH
SHIFTING SHAPE
The Shanghai contract's gravitational pull on Russian nickel is altering both the composition of LME stocks and the physical market premium structure.
Norilsk is the world's largest producer of full-plate cathode, a form of nickel that has historically accounted for almost all registered LME nickel inventory.
This is because full-plate has also historically been the cheapest form of refined nickel. It (Other OTC: ITGL - news) is too bulky for many manufacturers and needs to be cut into more manageable shape prior to usage, trading therefore at a discount to cut cathode and briquettes.
However, having once accounted consistently for over 90 percent of LME stocks, full plate inventory now represents just over 40 percent.
And it's noticeable that the decline, which has been running since the middle of 2012, has appreciably accelerated over the last six months or so.
The LME contract, it seems, is subtly shifting delivery shape. The largest component of exchange-registered stocks is now bagged briquettes.
And the physical market is also shifting shape, quite literally, in favour of Russian full-plate metal.
Red-hot demand for Shanghai arbitrage and physical delivery to China has translated into Russian full-plate trading at higher premiums than other forms of nickel despite the previously imbedded discount for cutting.
LME broker Triland Metals, for example, noted in its April 20 weekly physical premium report that Russian full-plate was trading at $40 over LME cash prices in the Belgian port of Antwerp, while briquettes were offered at $5-10 in Asian locations.
This is an inversion of past physical trading patterns and it is being driven by the startlingly fast rise of Shanghai as a nickel trading centre.
A TALE OF TWO CITIES
Right now, there is no reason why the ShFE and LME contracts can't coexist as Chinese domestic and international market-places respectively.
Indeed, the growth of trading in Shanghai may prove beneficial to London as the new Chinese contract stimulates both paper and physical arbitrage.
The future is less certain.
Beijing has made no secret of its longer-term ambitions to become a price-maker rather than price-taker of commodities such as base metals.
Will it allow exchanges such as ShFE to open up to international markets or will it favour the sort of connector model being pioneered in the stocks-trading space by Hong Kong Exchanges and Clearing, which now owns the LME?
Answers on a postcard.
What is not in doubt, though, is the steady rise of contracts such as Shanghai nickel, which is not only starting to influence pricing but changing the physical shape of the market as it does so.
(Editing by Susan Thomas)
