The Russia and Ukraine crisis have created countless second and third-order effects in markets that it’s dizzying.

Last week, we saw the nickel market come to a complete halt and shut its doors for over a week in response to a violent short squeeze.

In short, Russia is the world’s third largest nickel producer and the US and EU levied heavy sanctions on them, which prompted key Russian exports like nickel to rally and eventually develop into a short squeeze which left one “Big Shot” with a massive short nickel position into the squeeze. Drama ensues. 

Nickel traders are up in arms about the London Metal Exchange canceling billions of dollars worth of trades, and it looks an awful lot like the exchange did that as a favor to big banks.

It’s yet another market event that underlines the decay of trust between average traders and the financial system. It’s like an institutional metals traders’ version of GameStop. 

So what happened, in a nutshell?

• One of the largest nickel producers in the world, Tsingshan, held a very large short position in nickel.
• Driven by illiquidity, the possible cornering of the market, and the Russia/Ukraine crisis catapulting commodity markets, the price of nickel more than doubled in two days.
• Tsingshan’s losses were in the realm of $8 billion. And large banks like JP Morgan and China Construction Bank held the trades on their balance sheets. So the banks were in trouble too.
• In response, the London Metal Exchange (LME) halted trading in nickel, and canceled all trades that occurred on March 8, 2022.
• A consortium of banks, led by JP Morgan, agreed to extend Tsingshan more margin to keep their short position open.

A Quick Word on Nickel and the LME

Nickel is extracted from soil using a mining process, just as many other metals are, and is used primarily to make stainless steel.

Nickel has found a new growth engine in recent years with growth of battery-powered vehicles. In response to the insane price action, Tesla was recently forced to hike the price of their cars, as nickel is a key input cost in their production line. 

The London Metal Exchange (LME) nickel futures contract is the primary reference price in the industry, making the orderly trading on LME vitally important to the functioning of the physical nickel market.

The LME is over 100 years old, and has been historically run as an “old boys club,” benefitting from their monopoly-like status in certain markets like nickel. As a result, there have been a number of events before this that weighed on traders’ trust in the exchange throughout history.

In 2012, the exchange was sold to Hong Kong Exchanges and Clearing, which operates The Stock Exchange of Hong Kong, of which the Hong Kong government is the largest shareholder.

Who is Tsingshan Holding Group?

Tsingshan is one of the world’s largest nickel and stainless steel producers. Their CEO Xiang Guangda is a well-known Chinese entrepreneur given the nickname “Big Shot” for his propensity to make massive bets on commodity prices.

In his most recent big shot, Guangda used his company, Tsingshan, to make a massive short bet against the price of nickel, which of course his company is a large producer of.

It’s completely normal for commodity producers to short futures to hedge their holdings, however. This is a typical and non-controversial thing that almost every commodity producer does.

For instance, imagine you’re a wheat farmer and you’re profitable when the price of wheat is $5 per bushel. If the price of wheat is $11/bushel today, you could lock that price in by selling wheat futures. When you actually sell your physical stock, you can use the cash to close your futures hedge. 

However, it’s been widely reported that Guangda’s short is more than a simple hedge against their physical inventory, but an outright speculation that nickel prices will fall. 

For example, when nickel prices began recovering after its COVID-19 lows, Guangda started leaning hard on nickel, adding to his short aggressively.

Guangda’s nickel short is believed to total about 150,000 tons of exposure, making the notional value of the position roughly $3.7 billion USD at a pre-squeeze average price of $25,000/ton. Of course, we don’t know his average price, it’s just roughly where nickel was trading in the weeks leading up to the squeeze. 

The Squeeze

On March 8, 2022, the price of the Nickel futures contract on the LME reached an all-time-high after being listed for 35 years, reaching an intraday high of over $60,000 by 06:00 London time, from an opening price of somewhere in the neighborhood of $40,000, after opening in the $20,000s the day prior.

Daily percentage changes in LME nickel futures 

This was all happening in the wake of traders hurriedly adjusting their positioning as the Russia and Ukraine war was putting pressure on the global commodities market, with Russia being the world’s third largest nickel producer.

With nickel being a niche metal traded on an antiquated exchange (LME) that still hasn’t transitioned into electronic trading and still sports the high fees of an old school exchange, there aren’t a lot of speculators punting around money to add liquidity and diversity of positioning.

As such, the LME contract is overwhelmingly utilized by hedgers who short nickel futures in order to lock in prices for their physical inventory. When a huge swath of the market participants need to trade in order to avoid or fulfill margin calls, you get massive convex moves like this: 

Of course, we cannot understate the importance of Guangda’s presence. Nickel being a small, niche market, many of the participants are quite familiar with each other. Because most nickel traders knew full well that the biggest whale in the market was super short and held a huge portion of the LME’s inventory, they could pull a GameStop on him. 

Additionally, Reuters reported on March 8 that one entity held between 50% and 80% of LME inventories, it’s unclear whether or not that entity was Guangda’s Tsingshan, or perhaps another nickel that was trying to squeeze Guangda that we simply haven’t heard about yet.

Again, nickel is a pretty niche market that most people don’t care about so fetching good information can be difficult. 

The LME Halts Trading and Reverses Trades From March 8

All exchanges have mechanisms to halt trading when things get out of control.

The CME has limit-up and limit-down mechanisms and the US equity markets have volatility halts.

It’s a generally well-accepted principle that freezing trading for a brief time can give traders time to think and come out of their manic states, and more importantly nowadays, for programmers to fix potential glitches in their trading machines or shut them off entirely. 

So it shouldn’t come as a huge surprise that LME halted trading in nickel amid the biggest short squeeze in the contract’s history.

After all, nickel producers who are overwhelming short nickel futures are the LME’s biggest clients, it doesn’t make sense to allow the squeeze to go on and bankrupt all of your clients. Halting trading allows the producers to go seek financing against their nickel inventory to maintain their short positions. 

It’s the way that LME went about things that have traders up in arms. Not only did the LME halt trading, but they canceled all trades that occurred on March 8, effectively pretending the day never happened.

If you took advantage of the squeeze, bought a few contracts and made $100,000 on March 8, that money would have been taken from you. The CEO of the LME explained the halt by saying that nickel prices “were becoming disconnected, I believe, from the physical reality.” 

Furthermore, many, like AQR Capital Management’s (one of the world’s largest hedge funds) Cliff Asness, suspect foul play on the part of the exchange, that they retroactively canceled trades as a favor to the big banks and nickel producers.

Asness has called the LME “slime bags” and AQR is reportedly seeking legal remedies for having their profitable trades in nickel reversed. After all, all the trades were between a willing buyer and a willing seller. There should be no mulligans in financial markets. 

The LME kept the nickel market closed for over a week following the incident, not opening again until March 16. Even then, there were several stipulations and it was a disaster.

For trading on March 16, the LME set a 5% price band around a reference price of Monday, March 7’s close. The exchange was open for minutes before the LME’s system glitched and allowed trades to execute outside of their price bands. They halted the market again, and predictably, canceled all trades that occurred on March 16 as well. 

How Big Banks Saved Guangda From Bankruptcy

In wake of the short squeeze, tons of nickel producers were wrecked and receiving margin calls from their banks/brokers. Particularly, Guangda’s liabilities grew to the billions, with several media outlets estimating that the notional size of his short position ballooned up to the neighborhood of $8 billion.

Because the futures market works on margin; the exchange allows you to open a position with a nominal value of say, $220,000 with an initial margin requirement from you of $11,400 (in the case of E-mini S&P 500 futures), a broker has to extend you that margin.

So the issue became two-pronged. Guangda was getting margin calls from his brokers for the additional billions in collateral he had to put up to to maintain his position and those same brokers were simultaneously getting margin calls from the exchange to put up more collateral. If Guangda goes bankrupt, the brokers would be on the hook for the billions. 

Of course, because Guangda’s company Tsingshan is a massive nickel producer they likely have tons of physical nickel inventory to put up as collateral. The fact that this didn’t satisfy the banks’ margin requirements underlines a fundamental principle in finance: liquidity.

Selling physical nickel is a long process that takes locating and negotiating with a buyer, settling legal details, delivering it, and waiting for payment, which is unlikely to be instant. 

Under normal market conditions, the physical nickel would be fine as collateral but in the midst of a face-ripping short squeeze, cash is king. 

I’ve heard the quote “if you owe the bank $1,000, that’s your problem, if you owe the bank $1 billion, that’s the bank’s problem” many times since this debacle began and it perfectly explains what happened.

Some of Guangda’s lenders responded by simply “buying him in,” or liquidating his short position to eliminate their own risk. But many of his lenders didn’t want to throw in the towel. 

If Guangda and Tsingshan go broke, the banks are on the hook for billions of losses. So the bank’s first priority in this is to ensure Guangda’s solvency. This is why JP Morgan, Guangda’s biggest lender, led meetings between Guangda and all of Guangda’s lenders that went into the morning.

If they decided to extend Guangda more margin to keep his position, they’re still at risk of the market going out of control and ultimately being on the hook for an even worse bill.

The Fallout and Consequences for the LME

The LME’s legitimacy and trust just took a nosedive. Many in the hedge fund and commodity trading community are predicting doom for the exchange and even lobbying the Chicago Mercantile Exchange (CME) to create their own nickel contract to become the industry standard.

Alex Gerko, a large market maker, XTX Markets, that makes markets in nickel, called the LME the “Soviet Metal Exchange,” and made other harsh comments which ultimately predict the exchange’s demise.

Hide Not Slide, an expert on exchanges and clearing houses, said “when a big MM says it’s the end of a market, you know things are bad” of Gerko’s comments.

Many are highlighting the potential conflicts of interest within the LME, as the exchange is owned by the Hong Kong Stock Exchange, of which the Hong Kong government is a major shareholder.

Now that Hong Kong is largely under the control of the Chinese government, it wouldn’t be ridiculous to make the link that the Chinese government would want to protect their largest domestic nickel producer in Tsingshan and would pressure the LME to help that end. 

Of course, there’s no direct evidence to support such claims, it’s worth noting. 

The LME responded to these accusations by saying there was no favoritism involved in their decision to cancel the trades, instead that it was to serve the interest of physical nickel traders, which is their purpose as an exchange. Not canceling the trades, was in CEO Matt Chamberlain’s eyes, a build-up of synthetic risk. 

One more thing, it’s not a real market armageddon until a few ETFs linked to the product are decimated (see XIV, USO, RSX, etc.). WisdomTree’s 3x leveraged nickel ETF is the martyr of this crisis, as Bloomberg reports. WisdomTree calculated the redemption value as zero, so all investors are wiped out. 

Bottom Line

I said it earlier in this article, but I view this as the institutional trader’s version of GameStop. Back in January 2021 when brokerages began limiting clients’ ability to trade GameStop, a massive populist fervor erupted, even to the point that top names in US politics like Alexandria Ocasio-Cortez and Donald Trump Jr. were pitching in and calling out what they perceived as corruption and favoritism on the part of financial institutions.

With nickel being such a niche market that is largely inaccessible to retail traders, this time we’re hearing similar outrage from billionaire investors like Cliff Asness, and market making giants like Alex Gerko of XTX Markets.