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COLUMN-Still much darkness in LME's transparency drive: Andy Home

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

By Andy Home

LONDON, Feb 20 (Reuters) - So can you see clearly now?

The London Metal Exchange (LME) has been publishing its Commitments of Traders Report (COTR) for just over six months.

It was born from the LME's consultation on its dysfunctional warehousing system. While there was a multitude of conflicting views as to how to fix the long load-out queues, everyone agreed that more transparency would be a decidedly good thing in what has historically been a particularly opaque marketplace.

The LME duly obliged, taking the existing template used in U.S. markets to provide daily positioning reports, albeit released on a weekly basis and with a two-day time lag.

The COTR has since been closely tracked by just about everyone in the metals markets, particularly for what it says about speculative positioning.

However, so far at least, the outcome has not so much been greater transparency as greater confusion.

Everyone wants more detail. Not least Alcoa (NYSE: AA - news) , the U.S. aluminium producer, which rallied the LME's industrial user base to call for the report in the first place.


Some very strange things have been going on in the last couple of weeks' COTR.

The most transparent part of the report should be the "money managers" category, even if index traders are not included, a curiosity replicated from the U.S. template.

If any part of the report gives insight into investor positioning, "money managers" is surely it.

But then consider the first chart below, which shows managed money positions, both long and short, in the aluminium market.

On Feb. 4, money managers apparently increased their short positioning by 77,351 lots and their long positioning by 78,331 lots. Each component of that change is close to 2 million tonnes, although quite evidently the net change was much, much smaller. ******************************************************* Graphic on money manager positioning in aluminium: Graphic on overall positioning in aluminium: ******************************************************

"Apparently", because of course that's not what actually happened.

As the second chart shows, the huge increases in money manager positioning on Feb. 4 were complemented by similarly massive offsetting changes in the "broker, dealer, index trader" (BDIT) and, to a lesser extent, in the "producer, merchant, processor, user" (PMPU) categories.

The same pattern on the same day was seen across all the core LME metals.

This was, according to the LME, "the result of an update in account classification".

"The LME," it explained in an email, "relies on the membership to classify its business and will at times, as on this occasion, use its discretion to update account classifications."

The inference is that one, or maybe more, brokers were challenged about the way they were categorising their customers' positions before submitting the information to the exchange.

Interestingly, there were some more big increases in money managers' positioning in aluminium again last week, although without the offsetting changes in other categories.

Another change in reporting mechanisms? Possibly, but transparent it's not.


OK. So maybe we're getting a "truer" picture of investor positioning. Or are we?

Right now, money managers, according to the COTR, are net short of only one metal, namely lead.

Which seems counterintuitive given this year's bear price action across the base metals board.

Even more counterintuitive is what the COTR said about copper's ferocious selloff over the week of Jan. 12.

The net drop in managed money length totalled 4,585 lots that week, a slightly smaller decline than the previous week, and the "funds" were still apparently net long at the end of the week.


Marex Spectron, which runs its own proprietary "speculative positioning" series, estimated the net short on the LME was at a record high.

That copper selloff was triggered by Chinese hedge funds and ably abetted by some of the big-name Western macro funds, but you'd be hard pressed to find any evidence in the LME's figures.

So where are they lurking?


Most likely in that catch-all BDIT category, which accounts for by far the largest percentage of LME open interest.

Even after the classification changes of the last two weeks, the BDIT category, as of Feb. 13, represented 47 percent of long open interest and 40 percent of short open interest in the aluminium contract.

The money managers, by contrast, accounted for 32 percent and 22 percent respectively.

Yet there were just 117 reporting entities in the BDIT category as of Feb. 13, compared with 290 money managers and 326 industrial users (PMPU).

This highlights the limits of the current COTR in terms of LME business.

It is the nature of the LME market that much business between brokers and their customers is done on a bilateral over-the-counter (OTC) basis, with the brokers subsequently netting off customer orders before using the exchange to hedge the resulting net position.

Indeed, it is a well-known secret that one major bank now conducts customer business only on a bilateral basis to mitigate the costs of the latest raft of regulations.

The COTR can show us the net positioning, big enough in its own right, but not the even-bigger order flows that have generated it.

Which is why Alcoa, in an open letter to the exchange dated Feb. 6, wants it to force brokers to report "both OTC and on-exchange positions by segmented category, including any volume that has been netted".

Whether the LME can do so is a moot point, although its proposed scrutiny of warehousing incentives will inevitably entail just such a regulatory creep into the OTC physical markets, something which, ironically, Alcoa is very much against.


But when it comes to the COTR, Alcoa has quite a few suggestions for the LME.

It wants to see an additional report on volumes, also separated out by type of market player.

It wants to see the "message rate" of high-frequency traders, meaning the ratio of orders placed to orders executed.

And information on how often the LME's order ratio limits are breached and what action has been taken as a result.

Its contention is that money managers account for around 75 percent of total exchange volumes. Which is not what the COTR says in its current format.

In short, Alcoa wants still more light. And so does just about everyone else.

There is still too much darkness in a report intended to enhance transparency.

(Editing by Dale Hudson)

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