It’s been said before, but the best way to understand what’s happening in commodity markets today (and why they have become ultra-high-risk) is to remember that there is always more than one cockroach in the kitchen.
That advice might sound obscure, but when Chinese billionaire Xiang Guangda blew up the nickel market this week, he also disconnected commodities from the stock market.
Nickel hit US$101,000 a tonne on Tuesday, but pulled back slightly to US$80,000/t (or 380%) higher than last week before trading was suspended on the London Metal Exchange.
Xiang, also known as “Big Shot”, is the man behind Tsingshan Holding Group, an exceptionally successful nickel producer thanks to its mastery of converting low-grade ore mined in Indonesia into a material suitable for producing stainless steel – but not the batteries used in electric vehicles.
Unfortunately for Xiang he believed he could control the nickel market, which is why he short sold thousands of tonnes of the metal, planning to buy it back later at a cheaper price.
What he didn’t allow for, perhaps because the Chinese Government has been playing down the war in Ukraine, were trade sanctions (official and unofficial) on Russian nickel, sparking a price rally and a whopping margin call on Xiang’s short position estimated to be as much as US$5 billion.
The next events in this remarkable situation, which has occurred in other metals such as copper, silver and tin, is the unwinding of Xiang’s short trades – meaning a nickel crisis will quickly become a banking crisis.
The closest parallel is the Hunt Brothers attempt to “corner” the silver market in 1980, an outrageous plan hatched by boys with access to billions of dollars of oil money.
It went to plan until the US Government stepped in, and ordered an unwinding which destroyed their fortune and almost broke an American bank, Prudential Bache.
For the average investor, in big and small stocks, a simple test of how markets have become disjointed is to compare the nickel price with the price of well-known nickel miners such as Mincor (ASX: MCR).
While the metal was heading into the stratosphere Mincor’s share price fell by 7% ($0.16) to $2.05 because investors recognised that a false market in nickel had developed thanks to Xiang’s short selling.
Nickel is the first cockroach in the commodity kitchen, but it will certainly not be the last as other commodities in which Russia and Ukraine are major players are destabilised.
Oil is undoubtedly the biggest market to be upended, but other minerals and metals (coal, aluminium, potash, palladium and copper) will be affected, along with food crops such as barley and wheat.
Prices for commodities caught in the Ukraine cross-fire are likely to continue rising, but for how long is uncertain, as is the potential for other short-sellers being squeezed by margin calls.
‘Volatility of everything’
What started earlier this year as an “everything boom” is morphing into a situation described by one hedge fund manager as the “volatility of everything”.
There is not yet a full-blown rush for the exits but there is no doubt that a process of de-risking is underway with long positions being cut and short positions being wound up.
Citi, an investment bank, told clients Tuesday that commodity markets have fundamentally changed with duration of the change the key to what happens next.
Russia-Ukraine conflict prolongs commodity recovery boom
In the short term, it is likely the commodity prices will continue to rise, transformed by military action in Ukraine and sanctions on Russia. But a rapid reversal could follow.
“The Ukraine crisis looks to be prolonging the pandemic recovery boom,” Citi said. “We have raised near-term commodity prices materially.”
Examples of Citi’s fresh look at commodities include copper, up from an already inflated forecast over the next one-to-three months of US$11,000/t to $US12,000/t, and zinc up from US$3,800/t to US$4,200/t.
Nickel, which went off the dial this week, was forecast to rise over the next one-to-three months, from US$26,000/t to US$30,000/t.
But where the commodity-price tipping game becomes a worry is that over a six-to-12-month view prices are expected to retreat, with copper sliding back to US$10,000/t, zinc to US$3,400/t, and nickel to US$22,000/t.
“No matter what the outcomes, the world will have changed whenever the current conflict reaches a point of stabilisation,” Citi said. “Geopolitics will be different, but how different?”
“There are people who believe the results could be as transformative as what occurred after the two world wars of the 20th century.
“There are others who believe that the changes will ‘only’ be as transformative as either the end of the cold war or the aftermath of 9/11.”
Canaccord Genuity shares Citi’s caution with a focus on the demand destruction likely to be caused by super-high commodity prices.
“In the past, volatility in markets has commonly occurred at the onset of conflict, particularly in commodities where the conflict has involved major producers,” Canaccord said.
“The basis for our caution towards resource stocks this year are demand conditions, which still look likely to be moderating.”
“After surging in the pandemic, industrial production has already been slowing and may eventually fall as demand shifts, which should ease raw material prices.”
Impact on Australia
UBS, another investment bank, is confident that Australia will emerge relatively unscathed from events in Ukraine, while the rest of the world slows as inflation rises.
“History shows that geopolitical events don’t negatively impact Australian equities,” UBS said, citing research into 13 major events such as the Gulf wars and the Soviet invasion of Afghanistan.
“The standard reaction is for equities to initially fall modestly in the first week only for prices to subsequently recover over the following months.”
Volatility the key theme
A six-month view of markets after a crisis showed that gold outperformed other sectors (up 9.4%). General mining assets rose by 6.1% while energy assets were up 6%.
Banks on the other hand were down 7% in the six months after a crisis, beaten by insurance companies which dropped by 8%.
While the long-term view might be that a form of normality always returns when the shooting stops it’s what happens over the next few weeks which ought to keep investors on their toes.
In 2008, it was commodity markets in the front line as raw material prices soared and then crashed.
Copper flew up to US$3.80/lb before falling to US$1.40/lb, taking with it commodity traders caught on the wrong side of a deal (as just seen in nickel) and producers struggling to secure shipping as counter-party risk soared, a condition best described as “will I get paid?”.
For now, volatility is the key to all markets. It’s a wonderful situation for fleet-footed traders, but a potential disaster for anyone with a buy and hold mentality because no-one knows what’s coming around the next corner – just hope it’s not a bus (or a Russian tank).