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Geographical Risk and Chaos at Market: The Reign of Uncertainty

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The continuation of the conflict between Russia and Ukraine, along with the financial sanctions against Russia by Europe and the United States, has induced a shock in the international capital market. International energy prices, including oil and natural gas, together with commodity market prices, rose distinctly. In particular, the price of nickel has increased significantly in the past two days. There are market rumors that Chinese private enterprises have started to experience short positions, which might incur huge losses.

After raising more than 76% on Monday, the London Metal Exchange (LME) nickel price rose more than 110% on March 8 to USD 101,351 per ton, setting a new high again. Two causes are expected to contribute to the unexpected spike in nickel prices. First, Russia, as a major producing country, was kicked out of the LME because of financial sanctions. Because the LME was unable to supply nickel, it resulted in a significant supply deficit. Data show that in 2021, Russia’s supply accounted for about 9.3% of global nickel ore output, and Russia’s production was more than 23% of global refined nickel output. After the Russian products were banned, liquidity in the nickel market deteriorated remarkably, creating an advantage for the bulls. Second, global nickel inventories are already low, with nickel inventories in LME-registered warehouses falling nearly 70% to 83,328 tons since April last year. Market activity forces its price higher due to low supply, signaling more price volatility and potential for speculators to benefit.

As a result, this might have ramifications for the Chinese market. According to certain media sources, the 200,000-ton nickel short order made by Tsingshan Group, a Fortune 500 business in Wenzhou, may not be available in stock since Russian nickel was taken off the LME because of the Russia-Ukraine crisis and financial penalties. Some market rumors are circulating that Glencore might squeeze Tsingshan on LME Nickel for its 60% stake in a nickel mine in Indonesia. Tsingshan Group is the partner of Huayou that develops the nickel project. At present, it is not clear how risky Tsingshan’s position is from the rising nickel prices. According to certain media reports, Tsingshan’s floating loss might exceed USD 8 billion based on the scale of the lack of supply of 200,000 tons of nickel. If the price rally persists, Tsingshan’s short position could wipe out some of its production profits. Tsingshan declined to comment in multiple requests for inquiry, and Swiss financial trader Glencore responded that the claims were baseless.

There have been rumors that Chinese companies have encountered short-squeeze in the market. Bloomberg did report that Tsingshan started building short positions last year, in part to hedge against rising production with the belief that the nickel price rally would fade. Tsingshan’s production costs in Indonesia are less than USD 10,000 a ton, while the LME’s benchmark price is more than USD 23,000. It is believed that Tsingshan has accumulated large short positions in nickel derivatives markets to hedge against possible price falls during nickel production. The LME data shows that there is an unidentified nickel inventory holder who holds at least half of the LME inventory (as of February 9, 2022). The unidentified stockist holds between 50% and 80% of the nickel warehouse receipts monitored by the LME, according to LME daily data. Holder of LME warehouse receipt could withdraw the spot according to the warehouse receipt. The rival of this magnitude, it is believed, could be Glencore. Most important of all, the concern is whether Tsingshan will continue to compete with the bulls (Glencore) or close out the short positions. Bloomberg’s report pointed out that since Tsingshan’s nickel products are not eligible for delivery with the LME futures contract, its futures shorts are not a perfect hedge against its products. This reveals that if Tsingshan is forced to increase margin or move positions, these short positions would consume a lot of its cash flow.

Although there have been warnings through news reports, unfortunately, under the aggravated geographical risks due to the Russia-Ukraine crisis, extreme market deals have further exacerbated the Tsingshan Group’s position. This reveals that Tsingshan Group has not been able to effectively control risks and cease losses promptly. Some Chinese companies and investors, who often treat market risks with conventional thinking, are lacking effective early warning and risk control for external risks that cause an adjustment in the trading environment. Under the current aggravated geography risks, its impact often exceeds the market fluctuations in the normal state, bringing an unexpected influence on companies and investors. The condition recalls the rare phenomenon of “negative oil prices” in international crude oil futures during the COVID-19 pandemic. At that time, the acute contraction of crude oil demand as a result of the pandemic caused a rare negative value of crude oil futures prices. This extreme condition led to the liquidation of trading products including Yuan You Bao, causing huge losses to investors and financial institutions.

In the case of nickel, the LME had to suspend nickel market trading at 4 pm on March 8, Beijing time. It explained that the decision on the suspension was made due to the impact of the Russia-Ukraine crisis and the price trend in Asia. At present, margins on the LME nickel contract were based on the closing price on March 7, 2022. The LME Clearing would consider additional measures, if any, based on a risk management perspective. Market closures caused by such extreme transactions are rare not only in the LME but also in international commodity markets. This demonstrates that not only private enterprises were unable to take timely measures to deal with the aggravated geographical risks, but the market too had no effective solution on this. The latest information shows that the LME would delay the delivery of all spot nickel contracts originally scheduled for March 9, 2022. The LME also cancels all nickel trades executed on or after 12 am U.K. time on March 8, 2022 on OTC and LME select screen trading systems. This means that Tsingshan Group might recover some of the losses on the transaction. Because of the increased geopolitical risks, the futures trading market should have some control over risky transactions, but should not follow usual norms at this time. For example, for some extreme actions that may pose systemic risks to the market, the management should apply some limits so that the market and critical institutions do not collapse easily, given the implications for the entire industry. This is the sort of difficulty that the LME is facing at the moment. As a result, it is legitimate for the LME to interfere as needed.

Regardless of whether Chinese companies could recover their losses afterwards, it has become a lesson because the impacts are profound and painful. More important is that in the future, these companies must always be prepared in advance, rather than merely observing despite various early warnings. Researchers at ANBOUND point out that investors should learn the lessons and enhance their macro-judgment of geopolitical risks. The current rise in geographical risks has not only brought chaos to the commodity and energy markets but also affected the global capital market which could cause a major global financial turmoil. The overall market environment has undergone dramatic changes. Under this circumstance, enterprises and investors can no longer invest and operate merely from the perspective of market transactions, nor evaluate market risks under conventional thinking. The various market extremes exhibit that the current market is anything but a “normal” market now. Therefore, under the aggravated geopolitical risks, investment strategies and trading arrangements will require prudential contemplation.