LONDON, Nov 17 (Reuters) - London Metal Exchange (LME) nickel trading has turned wild again this week.
On Monday LME three-month nickel surged back above the $30,000 a tonne level for the first time since June and briefly breached the new 15% daily limit on price movement.
After peaking at $31,275 on Tuesday, the highest since early May, the price has subsequently imploded, retreating to $25,800 a tonne.
The LME has reacted by raising initial margins by 28% to $6,100 a tonne from Friday's close and by stepping up market surveillance activity.
Both the exchange and nickel market are now paying the price of the March meltdown, when the LME suspended trading and cancelled trades in a decision now being challenged in the British courts.
With funds giving devilish nickel a wide berth, trading liquidity on both the LME and the Shanghai Futures Exchange (ShFE) has shrunk significantly, injecting yet more volatility into a market that is prone to wild price swings at the best of times.
The fund exodus after March has left a liquidity vacuum and a self-reinforcing volatility trap in the nickel market.
"A lack of risk capital lowers market participation, driving down liquidity and exacerbating volatility, and further discouraging potential lenders and investors, reinforcing lower participation and higher volatility," Goldman Sachs warned in April. ("A financially constrained physical market", April 3, 2022)
LME nickel trading volumes have fallen steeply since March. October's average daily volumes of 32,811 were down 54% year on year and the lowest tally in at least a decade. Year-to-date nickel volumes are 24% below last year's equivalent period, the scale of decline flattered by strong trading activity in January and February.
The collapse in participation is even more stark in Shanghai, where ShFE volumes have collapsed by 71% over the first 10 months of 2022. Open interest at the end of October was 41% lower than October 2021.
While low liquidity has created outright price volatility in London, time spreads have been becalmed.
In Shanghai, by contrast, it's the spreads that are particularly unruly, the drop in liquidity coinciding with ultra-low exchange stocks and a long-running backwardation structure.
ShFE's registered inventory stands at only 4,634 tonnes and has been below 10,000 tonnes since April last year, creating a rolling squeeze that preceded the turmoil in London this year. The exchange hopes to repair liquidity by expanding its limited list of deliverable brands to include nickel briquettes.
But until inventory and volumes rebuild, time-spread turbulence and perma-backwardation are becoming the new normal in the Shanghai market.
Trading conditions in both London and Shanghai are accentuating price swings in a market that is not short of potential news triggers.
The sharp rally was at various points justified by Indonesia's plans to increase export tariffs (already known), a fire at an Indonesian producer (quickly denied) and possible disruption to Nornickel's flow of materials from its mines in Russia to its refinery in Finland.
The latter turned out to be at least partially true, with Finnish rail operator VR Group suspending Russian freight from next year, though Nornickel is examining other transport options, including by sea.
The search for a plausible bull price trigger also uncovered a minor tailings leak at Prony Resources' Goro plant in New Caledonia, which will run at a reduced rate over the fourth quarter.
None of this 'news' helps to explain nickel's 40% rally since the start of November. Rather, it underlines the ease with which rumours can roil an illiquid market.
And nickel is particularly sensitive to news flow right now. The status of Russian metal looms large, not only because Nornickel is a big producer, but also because it produces the type of nickel - Class I refined - that is traded on both the LME and ShFE.
The LME has decided not to suspend Russian nickel, but the threat of government sanctions will remain as long as Russia continues what it terms its "special military operation" in Ukraine.
Such uncertainty around a key cog in the global supply chain would translate into volatile pricing at the best of times. In the current low-volume futures market, it's a recipe for more wildness ahead.
So, too, might be the recent purchases of December call options with upside strikes such as $30,000 (now showing open interest of 489 lots), $35,000 (360 lots) and even $55,000 (25 lots).
A manifestation of bullish exuberance or a potential bull trap if the price starts motoring upwards again?
The size of these positions wouldn't normally be enough to generate an options accelerator effect on a bull price move, but with trading volumes where they are, anything seems possible with this market.
The physical nickel market is booming as it gears up to meet the new demand stream from electric vehicle batteries, but it is simultaneously losing the capacity to hedge its growing price exposure.
This disconnect has been building for several years. None of the nickel flowing from Indonesia, the world's new production hub, towards China's giant battery sector is in a form of the metal that can be delivered against either the LME or ShFE.
This mismatch of paper and physical markets was a key contributor to the March mayhem. Tsingshan Group's huge short position against its equally huge production stream was simply too big for a market defined by a shrinking Class I segment of the supply chain.
Events in March and the resulting drain in liquidity have accelerated the price fragmentation.
The long-term solution would be the evolution of different exchange-traded contracts for intermediate products such as ferro-nickel, mixed hydroxide payables or nickel sulphate.
Users would then have a financial structure within which to tailor their product-specific price exposure.
It's far from clear, however, whether the new battery-facing parts of the nickel industry have sufficiently evolved to create standardised alternative price methodologies.
Until they do, the LME and the ShFE are going to have to manage their troublesome nickel markets.
More restraints may be necessary.
The opinions expressed here are those of the author, a columnist for Reuters.
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