Saturday, December 03, 2005
On Copper's Recent Drop & Then Surge
$
The recent action by China's SRB (State Reserve Bureau) on London's
LME (London Metal Exchange) in buying back December copper futures,
to cover a short position by an alleged rogue trader, showed plenty
of naivete and incompetence. It was rumored, and presumably correct,
that the short-position was rolled over to 2006. A cursory look at
the prices showed that the short-term contract (December, 2005) that
was held as a large short position was bought back at a significant
premium whereas the new longer-term short position (maturing in 2006)
was sold at a significant discount. So instead of delivering copper
to LME warehouse in Pusan, S. Korea, SRB chose the lazy book-keeping
way out by covering the short futures and simultaneously selling the
longer-term futures. This "paper" solution was most advantageous to
LME market makers and brokers, and quite detrimental to SRB, as will
become clear. There could be little doubt that the LME copper short-
squeezers made a cash bundle both from SRB's short-cover premium and
SRB's new (2006) short position sold at a discount, especially given
the enormous transaction. Thus LME market makers called SRB's bluff,
and SRB winked, which was perhaps not quite surprising, considering
past blunders, incompetence and lack of ability of the SRB. Hence,
with big profits taken from both the premiums and discounts of SRB's
rollover, on top of elimination of physical delivery risk and a lot
of positional risk, it should not be surprising to see the LME short-
squeezers, now with a greater war chest than ever thanks to winnings
from the SRB, engineer yet another major short-squeeze on the SRB's
newly created (to mature in 2006) short position in copper futures.
Thus a price jump in copper stocks and futures should not surprise.
By covering its short via futures rather than physical delivery, SRB
removed the enormous risk that was facing LME copper short-squeezers.
The most frightening prospect for well-heeled short-squeezers is the
appearance of a big, well-financed bear to take advantage of grossly
inflated prices by dumping supplies, both physical and futures, that
overwhelms any further short-squeeze and then some. In fact dumping
at the spot market is quite powerful, but making the short-squeezers
of LME take physical delivery is a lot more so. But lifting a large
short position by buying back short futures, even if just a rollover,
is the worst course of action. Yet this was what SRB decided to do,
at the last moment presumably on "advice". Mathematically, it might
seem equivalent, but in reality, they are very different, especially
when large positions, in this case short ones, are involved.
Why? Short-squeezers are typically speculators and opportunists. A
majority never want or never care to deal with holding inventory and
warehousing, all of which cost money and tie up significant capital.
To avoid such headaches, most short-squeezers would rather close out
their long paper positons than take delivery. Therefore, simply the
prospect of having to take delivery would induce many longs to close
out their long positions and do it early, with downward pressure on
price. It will no longer be just a paper transaction, a paper game,
but playing it for real, if longs are obligated to take delivery for
failure to close out early. The option of delivering copper to meet
a short futures position was an advantageous option that the SRB was
able to exercise to cause a much greater bearish impact upon the LME
December copper futures market, and overall copper market, far more
so than selling or shorting copper futures.
Conversely, SRB's alternatives to making no physical copper delivery
were either to cover the short December futures or roll them over to
2006. Both alternatives require buying back the December futures at
the lastest moments, and given the time pressure, would cause prices
to rise, adding to the loss and cost of any short position. It was
thus very self-defeating and undesirable, yet this was what the SRB
decided to do and apparently did, creating a bullish effect on price
by driving it still higher --- certainly not a wise decision for SRB
that could deliver the physical. If SRB had followed through with a
conspicuous action to deliver physical copper to meet its LME short
position, to the nearby LME warehouse at Pusan, S. Korea, SRB would
have achieved a maximal, amplified bearish effect on copper price,
and saved itself a lot of money in the process. Instead of doing so,
SRB further created a bullish effect on copper futures via its open
market covering of December copper futures on the LME, and succeeded
only in shooting itself in the foot, creating yet another new, short
copper future position that may, and quite likely, be squeezed on LME.
So in effect, SRB acted to drive up the price of copper that it was
short and attempting to cover at less loss. In the process, the LME
market makers and short-squeezers were able to profit substantially
and yet again, at SRB's own further loss and expense.
As for PD and PCU, the moment news came out that SRB did not deliver
physical copper but instead chose to cover and roll-over via futures,
it became clear that neither PD nor PCU would continue to drop. Not
surprisingly, they both reversed their price drop and surged higher,
boding ill for the SRB's rolled-over copper futures short position.
The recent action by China's SRB (State Reserve Bureau) on London's
LME (London Metal Exchange) in buying back December copper futures,
to cover a short position by an alleged rogue trader, showed plenty
of naivete and incompetence. It was rumored, and presumably correct,
that the short-position was rolled over to 2006. A cursory look at
the prices showed that the short-term contract (December, 2005) that
was held as a large short position was bought back at a significant
premium whereas the new longer-term short position (maturing in 2006)
was sold at a significant discount. So instead of delivering copper
to LME warehouse in Pusan, S. Korea, SRB chose the lazy book-keeping
way out by covering the short futures and simultaneously selling the
longer-term futures. This "paper" solution was most advantageous to
LME market makers and brokers, and quite detrimental to SRB, as will
become clear. There could be little doubt that the LME copper short-
squeezers made a cash bundle both from SRB's short-cover premium and
SRB's new (2006) short position sold at a discount, especially given
the enormous transaction. Thus LME market makers called SRB's bluff,
and SRB winked, which was perhaps not quite surprising, considering
past blunders, incompetence and lack of ability of the SRB. Hence,
with big profits taken from both the premiums and discounts of SRB's
rollover, on top of elimination of physical delivery risk and a lot
of positional risk, it should not be surprising to see the LME short-
squeezers, now with a greater war chest than ever thanks to winnings
from the SRB, engineer yet another major short-squeeze on the SRB's
newly created (to mature in 2006) short position in copper futures.
Thus a price jump in copper stocks and futures should not surprise.
By covering its short via futures rather than physical delivery, SRB
removed the enormous risk that was facing LME copper short-squeezers.
The most frightening prospect for well-heeled short-squeezers is the
appearance of a big, well-financed bear to take advantage of grossly
inflated prices by dumping supplies, both physical and futures, that
overwhelms any further short-squeeze and then some. In fact dumping
at the spot market is quite powerful, but making the short-squeezers
of LME take physical delivery is a lot more so. But lifting a large
short position by buying back short futures, even if just a rollover,
is the worst course of action. Yet this was what SRB decided to do,
at the last moment presumably on "advice". Mathematically, it might
seem equivalent, but in reality, they are very different, especially
when large positions, in this case short ones, are involved.
Why? Short-squeezers are typically speculators and opportunists. A
majority never want or never care to deal with holding inventory and
warehousing, all of which cost money and tie up significant capital.
To avoid such headaches, most short-squeezers would rather close out
their long paper positons than take delivery. Therefore, simply the
prospect of having to take delivery would induce many longs to close
out their long positions and do it early, with downward pressure on
price. It will no longer be just a paper transaction, a paper game,
but playing it for real, if longs are obligated to take delivery for
failure to close out early. The option of delivering copper to meet
a short futures position was an advantageous option that the SRB was
able to exercise to cause a much greater bearish impact upon the LME
December copper futures market, and overall copper market, far more
so than selling or shorting copper futures.
Conversely, SRB's alternatives to making no physical copper delivery
were either to cover the short December futures or roll them over to
2006. Both alternatives require buying back the December futures at
the lastest moments, and given the time pressure, would cause prices
to rise, adding to the loss and cost of any short position. It was
thus very self-defeating and undesirable, yet this was what the SRB
decided to do and apparently did, creating a bullish effect on price
by driving it still higher --- certainly not a wise decision for SRB
that could deliver the physical. If SRB had followed through with a
conspicuous action to deliver physical copper to meet its LME short
position, to the nearby LME warehouse at Pusan, S. Korea, SRB would
have achieved a maximal, amplified bearish effect on copper price,
and saved itself a lot of money in the process. Instead of doing so,
SRB further created a bullish effect on copper futures via its open
market covering of December copper futures on the LME, and succeeded
only in shooting itself in the foot, creating yet another new, short
copper future position that may, and quite likely, be squeezed on LME.
So in effect, SRB acted to drive up the price of copper that it was
short and attempting to cover at less loss. In the process, the LME
market makers and short-squeezers were able to profit substantially
and yet again, at SRB's own further loss and expense.
As for PD and PCU, the moment news came out that SRB did not deliver
physical copper but instead chose to cover and roll-over via futures,
it became clear that neither PD nor PCU would continue to drop. Not
surprisingly, they both reversed their price drop and surged higher,
boding ill for the SRB's rolled-over copper futures short position.
