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.