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Global commodity markets bogged down last week as fears of geopolitical risk, exchange glitches, the risk of huge margin calls, caps on credit, and general price uncertainty sent a growing number of traders to the sidelines, taking markets’ liquidity with them.
“Liquidity” is a measure of a market’s responsiveness and fairness. It is determined by the number of active traders and open buy-and-sell contracts a market has at a given time. The more traders and contracts, the more sensitive a market is to changes in fundamentals.
As an example, a misbegotten trade in nickel shut down the London Metal Exchange’s market in the metal for a week, freezing liquidity and making it almost impossible to trade, as we reported in “London Metal Exchange Suspends Trading in Nickel” (15 Mar 2022).
In the wake of the nickel debacle, the London exchange canceled some trades that had already taken place, wiping out profits many investors were ready to claim.
On 18 March, sellers were lined up to unload their $3.3 billion worth of inflated nickel holdings at the exchange’s limit-down price but there were no buyers to take the deals, Bloomberg reported.
On 22 March, nickel traded within the London exchange’s limits, with more than 7,500 contracts traded before noon, more than the combined volume of aluminum, copper, and zinc.
Nickel’s troubles were contagious, causing price swings in other markets.
In aluminum futures, the cash-to-three-month spread stood at about $17 on 17 March, but scarce liquidity can push that spread to hundreds of dollars in a matter of hours as one or a few traders have undue influence, traders told Bloomberg.
With fewer traders in a market, the dominant orders increasingly are placed by computer algorithms that create absurdly low offers or unrealistic spreads, traders said.
In recent weeks, traders sold their oil futures contracts covering almost a billion barrels while benchmark Brent crude prices logged 16 consecutive $5-a-barrel intraday swings, the longest such streak on record.
“When prices can move $10 per barrel in either direction three times a day, no one can warehouse overnight risk and market makers are disappearing,” Energy Aspects analyst Amrita Sen said to Bloomberg.
Also, clearinghouses have jacked up the value of the collateral traders must post to trade. For oil and natural gas, those initial margins rose so much that traders had to almost double their collateral to trade the same amount of a commodity.
As a result, many traders are paring back their activities or not holding contracts for as long to reduce their risk, tactics that also reduce a market’s liquidity.
For European natural gas, the number of futures contracts held last week was nearing a two-year low, Bloomberg said.
Wheat contracts traded on the Chicago Mercantile Exchange skyrocketed in number at the outset of the Ukraine war as prices zoomed, but prices for the grain sagged last week as one wheat market booked its smallest number of active contracts since 2015.
“Volatility as an asset class is enormous now, and on top of that you have some serious operational issues,” Ilia Bouchouev, a partner in Pentathlon Investments, said to Bloomberg.
“It’s a vicious loop where volatility forces companies to reduce positions, which means what’s left in the market is forced trading,” he said. “That, in turn, contributes to even more volatility.”
TREND FORECAST: The greater and wider geopolitical conflicts escalate and the deeper economies sink, the more commodity prices will wildly fluctuate. Some prices will greatly spike higher because of sanctions and supply chain disruptions while other commodities tied to economic growth will decline as Dragflation takes its global toll.