We’ve covered to some lengths how easily manipulated the paper gold market is, and why investing in gold bullion is the only way to truly own the metal. But the issue is far from one that plagues just gold. Recent debacles in both the copper and nickel markets have reminded us how disconnected paper markets in commodities are from the real thing, and why avoiding exposure altogether is a prudent choice.
An investigation was launched after traders from numerous state-owned firms in Qinhuangdao city were made aware that a commodities storage is running thin. More specifically, the site that was meant to cover the over-the-counter copper market only has 100,000 tons of copper, as opposed to the 300,000 tons listed by the borrower. The total value of the missing copper is placed around $490 million.
In other words, two out of three investors who thought they owned a claim on real physical metal actually owned nothing but paper and a worthless promise. The paper would’ve been worth something (at least before the investigation) – the promise was equally worthless, before and after.
Remarkably, this is just one of several fiascos in China’s metals market in the span of a few months. Not long ago, Huludao Risun Trading Co was probed over missing aluminum deposits obtained with a similarly-borrowed $1 billion.
China’s issues with getting its hands on commodities highlight the strain that the Russia-Ukraine conflict has placed on the global economy, as well as the dubious strength of China’s own.
On Tuesday, London Metal Exchange halted nickel trading after prices more than doubled within the day, reaching $100,000 a ton. The price spike was tied to aggressive shorting by one of the world’s largest nickel producers. It’s the biggest crisis the exchange has faced in 145 years, and a throwback to both the 1990s copper market cornering and the five-year halt on tin trading in the 1980s.
Aside from suspending nickel trading, the LME also raised margin requirements significantly, though one could also argue insufficiently. As we know, over-leveraging is one of the biggest issues in the gold market in general, with paper gold market speculators exerting more than 30x the influence on the market compared to the metal they supposedly own.
BMO Capital Markets’ Colin Hamilton lamented how people will begin to doubt if the nickel market is a functioning one as LME also made deferrals of physical delivery of nickel. Once again, it was mentioned that Russia supplies 10% of the world’s nickel and up to 20% of the world’s battery-grade nickel.
While the invasion of Ukraine has undoubtedly strained supply, it has really only highlighted pervasive issues with the broader commodities market. Long before the conflict was mentioned, it was commonly-accepted that a full implementation of the Basel agreement could collapse the banking, if not altogether the financial system. Economists and pundits knew that banks simply don’t have the physical backing of the precious metal that they have been trading in in the spot market.
Both the halting of nickel’s trading and its explosive intraday rise in price should serve as a reminder of why the paper market exists mostly to fulfill a speculative pastime. Commodities, with gold hardly being an exception, are only really in someone’s possession so long as the vault is checked often and thoroughly.
Remember: if you can’t hold it in your hand, it isn’t real, physical gold – it’s just a paper promise of questionable value.