CME Group: Will They Achieve Liquidity With LME-Rival Aluminum Contract?

Well, it was going to happen sooner or later, wasn’t it?

After vilification from just about everyone, the LME will now probably face competition from a rival with the infrastructure – the CME Group Inc. – to create a viable alternative to the LME’s aluminum contract. The LME has seen the brunt of mounting criticism from just about all quarters, blamed for all the wrongs of the aluminum market (not least of which transparency of who holds aluminum positions.)

The aluminum contract is considered to be out of touch and unrepresentative of true market prices, according to major producers such as Alcoa. Exit queues of greater than 100 days, in some locations 200 days, mean the market has long since ceased to be a viable source for consumers and only has value to producers in as much as freight incentives offered by warehouse operators have pushed up the physical delivery premiums.

These price premiums bring much needed additional revenue to producers able to secure the premium in their sales – not always an easy exercise for vertically integrated smelters that struggle to pass on the premium to consumers of semi-finished products.

FREE Download: The Monthly MMI® Report – covering the Aluminum market.

So what’s the CME’s deal?

CME to Take a Bite Out of LME

An FT article this week reports that LME rival CME Group, the world’s largest futures exchange, will launch an aluminum contract to challenge the London Metal Exchange’s dominance of the largest base metals market.

Quoting Harriet Hunnable, head of metals at the Chicago-based group, the FT wrote, “Customers want a futures contract that is a viable alternative to other contracts available today (meaning the LME).” The LME’s aluminum contract has been the global benchmark for the $90bn market outside of China, although it took some years to secure widespread acceptance after its launch in 1978.

The LME only have themselves to blame for the current situation.

By not tackling the distortion of the physical delivery premiums and extended load-out periods, they have driven physical users to desert the market as an option for physical delivery or supply of metal. Industry has not accessed metal from the LME in North America for years.

In their defense, the LME would say any changes risked creating consequences that could have made the situation worse by creating other distortions, but such hand-wringing and can-kicking has brought them to the point where almost no one views the LME as a reliable indicator of true market prices.

CME Offering Liquid Enough?

Whether the CME can create sufficient liquidity to develop a viable alternative to the LME contract is another matter.

Emotions are running high at present and many users may be keen to create a more reliable alternative, but industrial consumers make up a minority of the exchange’s daily trades; hedge funds, merchants, investors and financial organizations will value liquidity and the CME may struggle to achieve that anytime soon.

Still, if nothing else, the threat of a rival contract may just encourage the deliberating LME board to find some creative solutions in their current review.

FREE Download: The Monthly MMI® Report – covering the Aluminum market.

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