(Bloomberg) — Some of the world’s most important commodities are becoming harder to deal with as geopolitical turmoil prompts snarky traders to rush out, to rapidly eroding liquidity. .
Prices of materials such as crude oil, gas, wheat and metals have become dangerously uncertain as a gap emerges between buyers and sellers who are facing huge financing stress. Markets have been stirred by fears of Russia’s invasion of Ukraine disrupting the flow of goods, although in many cases the rallies were quickly followed by price drops.
The London Metal Exchange’s embarrassing week-long suspension of nickel trading is an example of the market stalling following extreme price volatility. Liquidity is not present as some dealers attempt to close positions in the midst of re-opening of trade in the important metal.
Volatility is particularly difficult to navigate because some moves seem to defy fundamentals, such as hedge funds exiting long-term bullish bets, such that supply looks its tightest in years. Traders are finding it difficult to snap up any cheap cargo due to heavy margin calls and credit line caps.
“Volatility as an asset class is very high now, and on top of that you have some serious operational issues,” said Ilya Bouchov, Pentathlon Investments partner and assistant professor at New York University. “It is a vicious cycle where volatility forces companies to short positions, meaning what is left in the market is forced trading. This in turn contributes to even more volatility.”
Disruptions have been exacerbated by the historic Nickel Short Squeeze due to the Ukraine War. LME suspends trading as prices rise a record 250%, canceling transactions worth nearly $4 billion.
That stirred investors who stood to profit from bullish bets before last week’s close – and the mood has hardly improved as the reopening opens. Many formerly bullish investors are now waiting for buyers in a long line of sellers to endure the sharp price drop.
As of late Thursday, about $3.3 billion of nickel was on offer at the limit-down price, but there was not a single bid on LME’s order book. There were only two trades in the electronic market that day. Liquidity is a concern for consumers using nickel in stainless steel and electric-vehicle batteries.
Due to the decline in the business of other metals, there are signs of infection. This is bad news for manufacturers and end users as it could leave them exposed to more violent price swings.
There are signs of spillover in specialist tools used by LME traders to manage price risks. Three long-time participants in the options market said it has become increasingly difficult to secure quotes from dealers in recent days and the spread of trade between contracts is increasingly uncertain.
In aluminium, dealers say scarce liquidity between major contracts such as the cash-to-three-month spread is driving the price wild. For that spread, which was about $17 on Thursday, bids and offers are now often hundreds of dollars apart.
Traders say the difference is due to electronic bids that were probably placed by algorithmic traders, as in practice the spread should not reach such extreme levels. But with low liquidity and the retreat of many specialist traders and hedge funds, those low-ball orders are often visible on the screen.
There are clear signs that traders are retreating. Combined open interest on key crude and refined product contracts has fallen to its lowest level since 2015. Nearly 1 billion barrels of contracts were liquidated in a period that saw Brent post 16 consecutive $5-a-barrel intraday swings – its longest run to date.
Analysts at Energy Aspects, including Amrita Sen, said, “When prices can move as much as $10 a barrel in either direction thrice a day, no one can take the risk overnight and market makers are missing out.”
Clearinghouses increase the opening margin – the collateral traders place to finance their positions. In the case of Diesel, this means that traders had to deposit almost double the amount of cash to trade the same amount.
Traders said that they are increasing their positions and are not holding them for long due to volatility.
Benchmark European gas traded in the range of 140 euros ($155) per megawatt on one day this month – which is now more than the cost of the contract. Open interest is near a two-year low amid volatility among traders.
Even before the Ukraine War, Europe’s gas and electricity markets were extremely turbulent due to concerns about a lack of winter supplies. Rising costs forced German energy giant Uniper SE to borrow $11 billion to pay margin calls. German utility Steg GBMH and Norway’s Statkraft AS also had to boost liquidity.
“Gas prices require huge cash flows”, said Alfred Stern, who runs Austrian oil and gas company OMV AG. “So far, we’ve been able to manage it pretty well, but the last few weeks it’s been significant, say in the three-digit millions that we had to inject.”
Chicago wheat volumes rose at the start of the war in Ukraine as prices hit a record low, but declined this week. Wheat in Kansas City — the type closest to Russia — has the lowest open interest since 2015.
–With assistance from Michael Hertzer, Isis Almeida and Vanessa Dezem.