Things Are Getting Ugly behind the Commodities Curtain

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In today’s Money Morning…from bad to worse…the rot spreads…we need an alternative, and we need it soon…and more…

On Monday, Ryan Dinse told you about the oncoming ‘Berlin Wall moment’.

It was a warning for any investor to open their eyes to the rampant destruction of the free market.

If you haven’t already read it, do yourself a favour and check it out here.

Because what Ryan has to say is very important. The distortions of the recent nickel price fiasco on the LME is just the latest market injustice in a long line of examples dating back to 2008.

Hell, there are plenty of examples prior to the GFC as well, they were just far easier to conceal without the power of the Internet. The point is that you and I are relegated to always be second-class citizens in this matter.

There are no bailouts for the retail investor.

That is a privilege reserved only for the special few. And when they make a bad bet, like ‘Big Shot’ did, we are the ones who end up losing.

As Ryan suggests, it is this moral decay that is fuelling the downfall of traditional finance — a catalyst that may end up tearing down centralised financial markets like the Berlin Wall was torn down after the Soviet Union collapsed.

At least, we best hope it will only be torn down…

Because, right now, I’m more worried about an explosion that could lead to a lot more collateral damage.

From bad to worse

My concern is that this grandiose nickel story is more than just an outlier.

Because once you start digging a little further into this story, things get more disturbing. And while powerful players like Big Shot may have JPMorgan to cover their backside, the middlemen aren’t always so lucky…

See, what some people don’t realise about the commodities sector is that it relies heavily on physical traders. These are companies that manage the actual movement of materials between buyers and sellers.

Glencore is perhaps the most well-known example that you may have heard of. But there are plenty more big names in this space — businesses that are heavily involved in the same kind of market hedging that Big Shot was.

Trafigura, for instance, which made US$231 billion in sales last year, is another big commodity trader. And while it has profited nicely from the boom in these physical materials, its CFO — Christophe Salmon — has some concerns:

We are already in a vicious cycle on the futures market. I want to stress the impact that it will have on the physical market.

We are more and more engaged with governments in order to inform the governments of the likelihood of market disruptions, meaning stock-outs of certain products in certain regions.

What he is suggesting is that the cost of trading commodities may put further pressure on already strained prices — a situation that could lead to undersupply of key energy products to regions like Europe…

Salmon’s comments don’t even begin to cover the severity of this matter, though.

This isn’t just a case of a few traders landing on the wrong end of a short squeeze.

No, we’re talking about the potential for a full-on liquidity crisis.

The rot spreads

Back on 8 March, a consortium known as the European Federation of Energy Traders (EFET) released what can only be described as a cry for help.

In reality, EFET is a lobbying group that represents the interests of businesses like Trafigura, among others. And while lobbying efforts are infamous for blowing issues out of proportion, the tone of this announcement was desperate.

Here are some excerpts to give you an idea of what I mean (emphasis added):

In normal market circumstances these energy market participants are usually not experiencing such huge liquidity risks when they hedge their commercial risks and, hence, these firms remain solvent in usual volatile commodity markets.

However, market participants, clearing members and clearing houses are currently encountering major challenges in managing the impact of the current geopolitical situation. Massive price movements on European energy Exchange markets have resulted in massively increased margin requirements for market participants.

Since the end of February 2022, an already challenging situation has worsened and more energy market participants are in a position where their ability to source additional liquidity is severely reduced or, in some cases, exhausted. There is consequently a significant risk at hand that some firms might not be able to meet additional margin calls issued by their clearing bank, although they need to continue to hedge their physical assets to avoid exposure to market price risks.

Initial margin (collateral) requirements have increased by circa 6 times within the last 4-6 months. Market volatility has led to the average amount of Variation Margin required increasing by 10 times from one business day to the other.

To illustrate: Price levels for example for front-month Dutch TTF gas have moved from EUR 23 / MWh (July 2nd 2021) to EUR 75 (Jan 7th 2022) and exceeded EUR 300 in Mar 2022. An energy producer who hedges large volumes of Gas and Power via Exchanges had to pay an Initial Margin of EUR 1bn in summer 2021, had seen its margin requirements increased to EUR 4bn by October 2021 and ultimately to EUR 6bn in March 2022 — a sixfold increase without any change in the position being hedged.

The same company which normally expects to experience daily margin cash flows related to price movements of around EUR 50mn, now faces variation margin requirements of up to EUR 500mn within a business day due to the extreme volatility in prices.

The same situation will occur once the energy prices will decrease again, because then market participants supply power and gas to consumers will suffer from the same liquidity squeeze energy producers currently do.

The conclusion drawn from all this calamity discussed by EFET is a need for bailouts.

They want central banks to help cover the increasing cost and risk of these endeavours. A justification that they believe will help restore confidence in the market.

In other words, they want everyone else to foot the bill for their greedy bets.

As for what implications that will have for investors, it is far too early to tell. But if things aren’t resolved soon, and these EFET members don’t get the bailout they’re hoping for, don’t be shocked if we see some serious market pain.

All of which suggests that the ‘wall’ may be coming down far faster than anyone anticipated.

Which is why, if you’re just as sick of this market perversity as we are, then it is time to consider alternatives. As Ryan Dinse will tell you, Bitcoin [BTC] and cryptocurrency is one avenue forward.

It is an alternative that is by no means perfect, but it is far better than the mess we have now. You can learn more about why and how you can get involved right here.

Because whatever the outcome may be, it is clear that the dynamics of shady modern markets right now are simply not sustainable.

We need an alternative, and we need it soon.


Ryan Clarkson-Ledward Signature

Ryan Clarkson-Ledward,
Editor, Money Morning

Ryan is also the Editor of Australian Small-Cap Investigator, a stock tipping newsletter that hunts down promising small-cap stocks. For information on how to subscribe and see what Ryan’s telling subscribers right now, click here.

About Ryan Clarkson-Ledward

Ryan Clarkson-Ledward is an Editor at Money Morning.

Ryan holds degrees in both communication and international business. He helps bring Money Morning readers the latest market updates, both locally and abroad. Ryan tackles all the issues investors need to know about that the mainstream media neglects.

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