Is China Getting Sneaky in the Metals Markets?

While thumbing through the print version of Purchasing last week -- about the only time I read the printed version of periodicals anymore is when my Vista machine needs to go through its 5-10 minute reboot cycle thanks to some bug -- I came across a short article I would have otherwise missed on China's attempt to circumvent the London Metal Exchange (LME). A fascinating story, the piece notes that "China is roaming the world to source metals directly from Africa and elsewhere in order to cut out such middleman as the London Metal Exchange ... [in effect, they are] trying to avoid key commodity markets while it creates markets for Chinese exports."

According to Martyn Davies, an expert cited in the article, "The policy makers and powers in Beijing have an extreme dislike for the London Metal Exchange ... Why? It is a middleman and a consequence of the colonial economic construct and that is why the metal exchange sits here in London and not in Johannesburg.” Davies later notes that the Chinese "prefer to acquire the asset source and negotiate long-term off-take agreements for 20 to 25 years with the governments of commodity-producing countries."

Given that I'm not an expert in the metals markets or the LME, I thought I'd turn to my wife, Lisa Reisman, and her business partner Stuart Burns, who both have extensive experience as global metals traders and consultants, to comment on where China is headed with this. Here is what they had to say:

Lisa: "I'm not going to comment on the last sentence of the article as my learned colleague probably has more thoughts on that topic. But what I can comment on is that if there is enough market liquidity for China to set up its own exchanges, then it will do so. But that is a big 'if'. To make a market, there must be enough buyers and sellers. I'm not convinced that there are enough of either outside of the LME that would be interested in participating. But in the meantime, purchasing materials direct from African governments appears to be a logical strategy for avoiding non-value added middleman costs. However, the LME does provide advantages beyond being a 'colonial economic construct' and that relates to product quality.

As we say in consulting, garbage in, garbage out. Alternative plastic resins might be okay for certain applications but they are not acceptable in others. I am not suggesting that African products are all necessarily inferior but I personally don’t believe quality standards or adherence to such standards are as uniform across the board. In other words, there is a wider variation of quality levels among African producers than among Western producers. And if China is seeking to make new markets for its exported products, it better pay attention to the quality issue or all of those 'value-add' products will sit useless on the shop floor."

Stuart: "I think that it's Mr. Davies who has a problem with the LME and its perception as a 'colonial economic construct' -- not the Chinese. The Chinese are doing no more than every consuming country does in their efforts, and that is to secure sources of raw materials. In the 1800's and early 1900's government did it by conquest. But in more modern times they have left it to the multinationals and the sophistication of the global markets to essentially perform the same function.

We must remember China is still a communist state and many of its leading companies are just extensions of that state apparatus. Through them China is merely seeking -- in their centralized decision making way -- to ensure they have adequate supplies to fuel their rapid economic growth. A simple SWAT analysis 10 yrs ago would have persuaded them this was a sensible course of action in the face of the scale of growth they have been experiencing -- growth that has changed the global supply balance for all raw materials.

As to the LME as a middleman, if I could find a qualified economist anywhere in the world who would argue that the 0.25% (or less) spread between buy and sell that the LME makes on it's trades is not a fair exchange for the enormous benefits of liquidity and convenience that the LME brings to the international metals scene he would be rarer than hens teeth. In reality no consumer regularly buys their material from the LME, they merely use the market to either hedge their price risk or as a marker to fix prices over time.

Does Mr. Davies genuinely think these Chinese supply arrangements in Africa will not have price risk mitigation strategies associated with them? And what is the benchmark for the price movements those strategies will seek to track -- the LME of course. I do not see some covert attempt by China to bypass the existing institutions of global trade, as an emerging player in that trade I see China becoming an increasingly important part of that interdependency and would welcome the participation of Chinese corporations as ring dealing members. Direct mine ownership and use of the LME are not mutually exclusive; on the contrary they are complimentary activities."

If you think Lisa and Stuart are full of it -- they certainly accuse me of that on occasion -- or you like what they have to say, drop 'em a line at lreisman (@) aptiumglobal (dot) com or sburns (@) aptiumglobal (dot) com.

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