Hedge your risk at the LME

The LME is still primarily an exchange for producers and consumers 

to hedge there risk with the use of futures contracts. 

By Mª Victoria Gomis Sanz
People shouting, running, writing, waving hands, secret codes, phone here, phone there, you only have five minutes! Get the deal done! This is how the traders agree on the everyday prices at the London Metal Exchange (LME). The last physical place to deal with metal prices is in the floor room at the LME based in the City of London.

Sellers and buyers get in touch face to face at what is called “the ring”. Everyone wears a badge, and only people with red badges are allowed to sit in there and trade. 12 are the dealers sitting in the red leather sofa inside the ring trying to get an agreement on what the price of industrial metals will be. 80% of non-ferrous metals are trading in the LME such as Zinc, Cooper, Aluminum, Tin or Nickel. And volumes and prices vary from day to day depending on what is happening in the world.

The total amount the LME traded last 2011 was $15.4 trillion, 3.5 billion tonnes and 146 million lots. What translated into the Copper price, for example, is £7720 a lot approx. Copper, Aluminum, Lead and Zinc weight 1 lot, 25 tonnes. Therefore, a day on average buying and selling, LME can take an account in the electronic system on £10000 lots of Copper (or £25000 lots in a busy day). Besides, trades on the ring that have to be added after, since the “outcry” goes through the electronic trading platform.

The financial tool used at the LME is often the three months forward contract, because this is the time a ship takes to go around the world to deliver the goods. At that time, you adjusted it for cash. However, if you need the metal sooner or later you use what it is called the “carry” on the electronic platform, that basically means the movements of selling and buying back the futures. They are not cash settles, like in the stock market, but what you buy or sell in the LME is the metal.

Hedges or speculation is the financial tool that is now use to lock in the price for a future delivered. Through it, they manage the risk of changes in prices in the future. The exchange is very actively traded by hedge funds but the contracts remain physically delivered. Banks as Barclays has a lot more hedge funds business than Triland, for example.

Thomas Steward, the Director of Newedge summarizes the trading with one sentence “at the end it is all about liquidity”. This is all about futures and options, the financial instruments the LME works with. That means what you will be willing to buy and sell in a fixed date. Prices change everyday, and products become more expensive in a long-term due to the extra cost of maintaining your goods. Storage, transport or salaries of the employees are an important part to take in mind when prices are set in a future contract.

However, what it is more interesting are the secret codes. The waving hands from the dealer´s clerks standing behind the trades. In that particular moment you can tell what it is going on. Numbers. If the hand shows numbers up, it means the price you want to buy that metal, and if the hand is opposite down means the price people want to buy it at. The agreement comes exactly when the hand is shaking. Bingo!

4.45pm that is the time when everything will get set, and prices and agreements make their shape. 15 minutes to the close, nerves rise. The room is chaotic. Everything happens so quickly.  Information goes back and forth in the room thousand times. One of these 12 men, a Company´s dealer from LME explains, “LME is all as simple as you want to sell your product at a specific price and you need someone to buy it at the same price, how to negotiate”. Basically, the information coming from everywhere in the world is reduced to the ring.

Nevertheless, the market reminds open almost 24h a day between the London, New York and the Tokyo offices, what means that market metal prices are available to investors anytime. Since 1877, the LME has become the biggest and most influential market. And it is the Europe´s only remaining ‘open outcry’ trading floor on London’s financial markets. This place is different from other markets since it gives you trust and it brings stability to the clients. Besides, it is widely recognized as almost the benchmark of metal prices.

U.S. leadership position threatened

I was reading and article bt Bill Emmott in The Times from October 24, 2011 and it is still actual. That makes me think that yesterday news are still today and tomorrow´s news. We usually think time pass so fast, but things are not changing at the same spead.

The mentioned article has as headline "Why we should fear America’s China-bashing", and it is explaining the    tough "fight" for being the first world economy. But, what it really called my attention is the sentence at the very end mentioned that "the euro will determine whether the world is going to face another financial crash". Do you think the euro is able to assume this heavy  responsibility? I will defend it but we need measures that really help the economy rise again.


In the current financial situation, protectionist measures as trade barriers are being raised and if you compare U.S. and Chinses growth on GDP or size of their economies, data scare. 10 years they predict. Lets keep the yesterday news on mind just to say, there it was.

14N: There is not "them"

Amid of the harshest recession in the European Union, there are countries like Greece, Spain, Portugal or Italy thaat cannot bear more auterity measures. Today, 14 of Novemember, 2012 thier citizens are striking in the streets fighting for their human rights.

Greece
Eurozone is standby the resolution of IMF and Eurogroup to reach an agreement over two-year extension debt in Greece. What Greece is supposed to do is to get its debt down to a 120% of the GDP by 2020 (or what they are trying now until 2022).

Also, goverment is seeking to avoid the €5bn default thought T-bill auction, but as the FT exposed "Greek banks expected to buy the issue can only raise about €3.5bn of collateral acceptable to the European Central Bank".

Greece is still the biggest problem of the Eurozone, but Eurozone finance ministers should release the next aid by November the 20th.

Spain
The Spanish situation is not getting better either. Evictions have provokes two suicides already from vulnerable homeworkers to pay thier mortages. Central government is taking action to limit the foreclosures for two years. This is linked with the debate over banking reform and the so-called "bad bank" which will start working at the end of November with €5bn. Reuters explained that "the bad bank will initially receive €45bn in assets from the four nationalized institutions".

Besides that, the uncertainty over the bailout is still worring investors. On the other side, Spanish citizens will not see many changes in Goverment policy at least until the unveil of the budget deficit target (that it must reach a 5.5%).

The 14N is the second general strike in less than a year in Spain. The desesperate situation in Spain is aggravated by the 25% unemployment rate.

Portugal 
After the visit of Angela Merkel to Lisbon last Monday the 12th of November, 2012, anti-austerity protesters held placards telling her she was not welcome, as Aljazeera showed in a report. Besides that, some activist (4,226) wrote a letter addressed to Ms. Merkel where it explains that taking more loans from the Troika is not the solution for Portugal. Portuguese video information prohibited in Germany here.

Portugal also reaches a 16% unemployment rate, and to impose more austerity measures will only produce a deeper recession.

Italy
Italians have also similar problems. Now  Italy is about "to indict five S&P employees and two from Fitch Ratings for market manipulation" connected to their downgrades of Italy’s credit rating, according to the Telegraph information.

However, Mario Monti efforts seems to produce positive effects by 2013, according to Bloomberg with  less deep recession compared with 2012 (a GDP drop of 0.5% in 2013 against 2.5% of 2012) due to a reduction in the unemployment rate.

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All this information regarding to the most affected countries of the Eurozone does not mean "they" are the only ones to be hit by the financial crisis. Specially because this is a global crisis. today, 14N there are 23 countries demostratiing against austerity measures (France, Belguim and Germany among them). As the BBC news is showing today, UK will recover slowly from recession. However, according to King: "Output might shrink again in the last quarter of 2012".

This is not a battle between the South and the North European countries. I believe in a common solution, with deeper integration among all of Us. Perhaps, more regulation over the market will be the solution, to cede a bit  of sovereignty to the Union, or to create the banking union, etc. There are many possibilities on the table, they (We) only need to get an agreement all together. "There is just no work" information of BBC about today demostration, specially in Spain and Portugal. The problem is that demostration will not change anything about the current situation, unfortunately.

 In the overview, I will add that other countries in the world are also suffering the consequences of the global financial crisis, as Japan or U.S.

Many reforms, no positive results

Almost one year after Mariano Rajoy was elected president for Spain, there has been many major domestic and international changes. Spain's center-right conservatives swept convincingly into power as it usually happens when a financial crisis threatens the economy. Since then, drastic economic reforms has taken place in the country, specially fiscal and structural adjustments. Spanish´s Prime Minister said last 31st of October to Reuters that “Spain will come out of its current crisis through a combination of domestic reforms and policy decisions taken at a European level”. Is it the request of the bailout one of them? Lets analyze the situation.

The Spanish government is set to pass 43 new laws to reform the economy within the next six months. And the new budget entails 58% spending cuts and 42% increased taxes, according to the information published in Russia Today last 27th, September. Some of these austerity measures include reducing €10m spending in education and health, increase of taxes (for example up to 21% in the value added tax) and fees or the controversial labor reform. Spanish government is willing to reach an objective target of 5.5% of the GDP with a reduction in expenditure of more than two thirds. This will deposit a total revenues of €30.3m (GBP24.19m) in 2012.

However, in the European framework there is not such a positive view of the Spanish recovery in a short term, and many external pressures are pushing Spain to ask for a bailout of its economy. Risk premium of Spanish 10 years yields bond is still above 400 basis points compared with German bunds. Besides that, foreign direct investment (FDI) was reduced to GBP15.83bn in 2011 half of the amount when compared to the previous year according to the World Bank. Even when the Spanish Minister of Economy came to London last 11th of October to ask for foreign investment, it has not been any change since then.

This information, along with the reduction of exports and imports, has made Spain to loss competitiveness in a international market. Spanish´s balance of payments has a negative commercial balance of €-3.1m (GBP-2.42m) according to data provided by the National Statistic Office (Aug,2012). The World Economic Forum expresses this insufficient competitiveness in 2012 because “the high levels of public debt coupled with low growth. [...] And political gridlock in some European countries stirred financial markets’ concerns about sovereign default and the very viability of the euro”. Spain is ranked 36 in the global competitiveness index with a 4.60 score (where Switzerland ranks first with 5.72 score).

Concerns in the eurozone countries have reached to Brussels, where it has announced to Spain and Italy the creation of a “Super commissioner” figure to exercise tighter control over budget as it was reported in the Spanish television last Thursday 29th, October 2012. Mr. Mario Draghi has made clear that they will do whatever will be necessary to keep the eurozone together, driving towards a greater integration, as the only safe way to protect the single currency.

Meanwhile, Spanish economy continues into recession, as the annual variation of the GDP represents in  the third quarter of 2012 (-1.6% in the Q3/12 compared to -1.3% in the Q2/12). This result is a consequence of a “negative contribution of domestic demand, partly offset by a positive contribution from external demand”, according to the National Institute of Statistics of Spain (press release 30th October, 2012). In the same direction, unemployment has increased until the 25% of the population on the 3Q/12, and the government gross debt reaches a general amount of €87.9bn (GBP70.9bn) in 2012 according to OECD data.

This data makes people wonder why Spain has not yet asked for the bailout from the EU. However, the decision is not an easy one. The main problem is the huge amount of debt from financial institutions. The global crisis of 2007 hit specially Spain because the great bubble housing speculation, where banks gave many loans and credits to people who could not return the payment. Now, institutions as Santander, BBVA or Bankia face an important recapitalization of their public debts, through cuts in Spanish population budgets.

While there has been many reductions of social expenditures since December 2011, Spain is running out of money and places to get it from. The Spanish government is now resorting to taking money out of the pension funds. This is one of the biggest problems. There are millions of Spanish families without any member of the family working, many are living with just the pension of their grandparents. This situation is exacerbated since family cannot pay the mortgages and banks are evicting 500 families a day.

The controversy is made by two sides of the question. If Spain requests for the bailout will imply tougher measures from Brussels. However, if Spain does not reach a deficit of 5.3% of the GDP by the end of 2012 it will have  no choice, but to ask for bailout. The social impact on Spanish population will mean more cuts, reduction on pension funds, frozen wages and increase on inflation (what is it already at 3.5%). On the other side, the bailout will go to recapitalize the banks, and not to the wealth of the population, who will suffer even more the consequences.

A year ago, monetary union was destiny to die due to European banking meltdown and the controversy about the measures in the single currency. Today, when a possible debt forgiveness for Greece is on the table along with some more austerity measures, the ECB is willing to buy unlimited Spanish bonds in the second market. Although Germany has the last word, it seems like the single currency is being saved for an imminent break down. Now the question is, what conditions is Brussels going to impose to Spain in the new “package” of measures for bailout? And even more, what consequences will imply for the Spanish population?