By Amrith Ramkumar
Shanghai is encroaching on London as the hub of the metals trading world -- a shift that investors say threatens to erode the reliability of copper, zinc and aluminum prices as a read on the health of the global economy.
Trading volume on the Shanghai Futures Exchange nearly tripled in the period between April 2013 and July, data on averages compiled by IHS Markit show. Metric tons traded in Shanghai have climbed each year since 2013.
Futures and options volume on the London Metal Exchange, long the center for global metals trading, fell 12% from 2014 to 2016 and is roughly flat this year, according to the LME, which is still the leader in physical trading.
Because industrial metals like copper are used in the manufacturing of items from bridges to electric vehicles, they have long been used to gauge the likely course of future economic activity. Now, analysts say speculative Chinese investors -- ranging from hedge funds to retail bettors -- risk distorting that picture by accelerating price moves in either direction.
That is fueling concerns about whether prices are becoming severed from supply-demand dynamics found in the world.
"Heavy speculation can amplify moves in an extraordinary and unwarranted manner," said Tai Wong, head of metals trading at BMO Capital Markets. "This makes base metals a less reliable global economic indicator."
Commenting on the increase in Shanghai volume, an LME spokeswoman said the two exchanges should be viewed as complementary platforms. "There is some overlap in participants but a change in trading on any venue does not automatically result in a change for another venue," the spokeswoman said.
Companies that produce commodities typically hedge using futures or options to guarantee a price for their output. In contrast, speculators use futures and contracts to try to turn quick profits.
In the U.S. and London, traders and analysts get weekly data consistently on whether commodity producers and speculators are positioned for rising or falling prices and how active they are moving in and out of positions. But in other parts of the world, especially China, this data isn't as readily available, making it harder for investors to surmise which way speculators might push prices next.
Still, pinning down how much speculative bets are influencing prices remains an essential question in countries like China, and analysts around the world have to try to answer it with limited data.
Chinese speculation was "the key driver of the rally" in base metals this year, said Michael Widmer, chief metals strategist at Bank of America Merrill Lynch. "We've virtually not seen any improvement in underlying fundamentals."
China has long been a focal point for commodity markets. The nation is the world's largest metals consumer. But now, it is also become home to massive trading in metals. Because the government has taken steps to cool the property market and the country's normally volatile stock market has calmed, Chinese retail investors have turned to base metals in recent years to generate rapid returns.
Analysts said they prefer to trade on an exchange within the country because it is easier than trading on foreign exchanges like the LME.
On some days this year, the reactions in prices to reports left many in the metals market confounded. Prices rose even after information that typically sends copper and other base metals lower. On such days, some fundamental investors and analysts blamed speculators.
Data on Aug. 13 showed the pace of Chinese industrial output, retail and housing sales, and fixed-asset investments decelerated in July. Still, after two days of muted moves, prices of copper, aluminum and nickel went on to rally for the week and continued rising for the rest of August.
On Aug. 29, U.S. mining giant Freeport-McMoRan reached an agreement with the Indonesian government over a key mine -- a potential blow to copper prices since disputes between the company and country had limited supply. Yet prices went on to advance in five of the next six sessions. Many analysts use copper as a benchmark to gauge the performance of the wider industrial metals complex because of its widespread uses and prominence.
"Bullish news is being used to buy, but bearish news is being ignored," said Daniel Briesemann, an analyst at Commerzbank. He said the 16% gain by an LME base metals gauge between May and August appeared largely driven by short-term players. The LME gauge had been roughly flat this year before then.
Copper prices have fallen 2.3% from a nearly three-year intraday high last month. After about a four-month rally earlier this year, prices of nickel and iron ore have each tumbled at least 8%. Still, prices of copper, aluminum and zinc are each still up more than 20% this year.
Many investors and analysts are nervous ahead of the Chinese Communist party's leadership transition this month, which could bring changes to economic policy and spark a period of volatility in commodity prices.
Some investors and analysts attribute the rally in base metals this year to synchronized global growth and potential supply deficits. They note that bullish bets on metals have increased in other parts of the world.
This summer, net bets by hedge funds and other speculative investors on a higher copper price set records for six straight weeks, according to Commodity Futures Trading Commission data going to back to 2006 tracking CME Group exchanges. The same trend has held in London, where bets that copper prices also hit their highest level in years.
But others still say it is uncertain what's driving gains.
"We're trying to get our heads around it," said Robin Bhar, head of metals research at Société Générale. "It's very much a black box."
Write to Amrith Ramkumar at [email protected]