A market corner isn’t lurking behind every surge

Something is afoot in the copper market.            

After drifting sideways since early May, during a period when most other industrial metals have surged, copper prices have lit up in recent days. Benchmark three-month forward contracts on the London Metal Exchange (LME) closed Monday up 14% from the start of the month. Cash contracts for immediate delivery were up 26% over the period.

Most dramatically, the spread between the pair — often watched as an indicator of fundamental demand, since consumers who really need the metal can rarely wait — soared to more than $1,000 a tonne, roughly a tenth of the $10,196/tonne forward price.

Such wild behaviour in commodities often evokes suspicions of a market corner — when a powerful trader ties up so much of the available inventory that genuine users are driven to offer them extreme prices, resulting in handsome profits.

A corner helped push the price of silver to record levels in 1980.  A failed zinc corner in 1992 led to the birth of Glencore from the ashes of legendary commodity trader Marc Rich & Co. Another in rice contributed to the 2014 downfall of Thai prime minister Yingluck Shinawatra.

Sure enough, a shadowy private commodity trader has been unusually active in the copper market of late. Trafigura Beheer withdrew a significant proportion of the copper that has been pulled from the LME’s warehouses in recent months, people familiar with the matter told Bloomberg News this week. The LME introduced special temporary rules on Tuesday “to ensure market orderliness” and the finance blog ZeroHedge described Trafigura as the “culprit for the chaos in the copper markets”.

Look to another commodity on the far side of the world, however, and copper’s activity looks downright somnolent. Thermal coal traded on China’s Zhengzhou commodity exchange has jumped 32% so far this month, leaving it up 161% since the start of the year. Once again, disappearing inventories are to blame. 

It’s a lot harder to put this down to the activities of nefarious commodity traders. China’s markets are far more dominated by mom-and-pop retail investors than their equivalents in other countries, as demonstrated by the higher velocity of buying and selling (professionals try not to pay the exchange fees associated with transactions unless they really have to). 

The big players in the thermal coal market are overwhelmingly state-owned: miners such as China Coal Energy, utilities such as Huadian Power International, or miner-utilities such as China Shenhua Energy. As such, there’s little of the natural oppositional tension you would see on the LME: all players are guided by the government, as demonstrated by the collapse in coal prices on Wednesday after Beijing’s economic planners promised fresh measures to rein in the rally.

Furthermore, if there has ever been a time when China’s nascent commodity trading market should be on its best behaviour, it’s right now, when the government is on a campaign to promote “common prosperity” as a promise to stick up for the little guy against rapacious capitalists. 

The better explanation for both situations is the normal precaution that we see in any supply chain awakening from a long slumber. Commodities don’t just dry up because of a first-order effect, where end users are buying up the stocks they need — the more important factor is often the second-order effect, where the same users buy up materials they don’t need because they are worried if they wait any longer their competitors will get them instead. Trafigura is naturally a big player in buying up LME copper inventories, as it is the biggest pure trader in the market.

We were already seeing signs of this earlier this year, with Toyota breaking its famed commitment to lean manufacturing to build up a buffer against the chip shortage that has hit vehicle makers worldwide. In the US, the Institute of Supply Management’s gauge of business inventories in September was the highest it has been since the early 1980s, barring a couple of blips in the wake of the 2008 financial crisis.

Looked at through that lens, Trafigura’s activity in the copper market seems quite as routine as Shenhua’s activity in coal. Both players have customers who depend on them to deliver a constant flow of raw materials. In both cases, a prolonged drift in the market has lulled participants into missing quite how tight conditions were about to get. Chinese copper demand tends to peak towards the end of the year, as buildings that consumed steel and cement in earlier stages start being fitted out with wiring and electrical appliances — but available inventories have been plummeting. 

Of course, the difference between a prudent trader locking down supplies for its customers and a nefarious one driving its competitors to pay over the odds to secure supplies is often one of perception, absent a string of incriminating text messages.

One advantage of market corners is that they can be fiendishly difficult to prove. 

Bloomberg Opinion. More stories like this are available on bloomberg.com/opinion