Brexit or no Brexit, international trade can be as tricky as it is rewarding. Playing to one’s strengths and making the most of another’s talent, the world will be a better place and we shall all benefit, is the basis of classical economics currently espoused by the liberal elites. Global trade has certainly added to wealth across all nations; the trouble is, it hasn’t been evenly distributed, and many have realised this at last.
So, a backlash began and might take us anywhere. International bodies set up to police these things, such as the World Trade Organisation and the United Nations, are often hamstrung by their own rules and powerless when lawmakers ignore their dictats. If taxes, quotas, sanctions and other punitive actions are taken, over time it will cause imbalances to appear. As important, without a level playing field price discovery is far more difficult and no one knows what anything really costs.
This is especially important in financial markets, starting at it very core: the cost of cash. This week Stuart Williams, president of London-based Intercontinental Exchange, warned that financial stability could be at risk if global market standards were not aligned because of prescriptive EU rules. His exchange is at the heart of financial derivatives which handle trillions per year. These determine the cost of bank funding and their ability to hedge assets. Posting margin on a net basis slashes costs and centralises the back-office function.
Recently the aluminium market has suffered from President Trump’s proposed import tariffs and sanctions. It is not the first time the rolling three-month forward on the London Metal Exchange (LME) saw a sudden short squeeze, from $2,000 to $2,750 per tonne within the last four weeks. At the moment, technically, the spike high looks more like the dramatic culmination of the bull market that started in 2016. Something similar happened in 2006 close to the record high.
The next chart is the active futures contract, also on the LME, currently May 2018. The first notice day is the 14th and the last delivery the 16th, so rather than a rolling three-month contract – keeping the same time to maturity – this one will expire in 15 days’ time. Obviously, the prices of the two are closely related, the difference between them being the cost of carry and the chance of immediate versus later shortages.
Shanghai aluminium futures for June 2018 delivery are traded as yuan per metric tonne, 1 US dollar being worth 6.305 of the Chinese unit. The salient feature of this chart is that April’s small bounce is a countertrend rally in last year’s bear market. Admittedly, the yuan has strengthened over the period but does not account for the glaring difference between Europe’s price trajectory and that in China. This is known as fragmentation, although normally these would be arbitraged out by market professionals.
Another casualty of potential changes in trade agreements has been the price of random length lumber futures on the Chicago Mercantile Exchange. The threat that Canadian imports will be banned saw prices soar from US$220 to $555 per 1,000 board feet (the contract is for 110,000 board feet). A new record high, this is seriously detrimental to the US construction industry and the cost of housing because wood is used extensively in the US. Not good news, just another shortage.
