Black Swan Events: The 2022 LME Nickel Crisis
In March 2022, nickel prices doubled in a day and hit $102,000/mt overnight. The LME froze, cancelled all trades, and shook the global nickel market.
What Is a Black Swan in Trading?
Events like this are known as Black Swans. They are so rare that it is extremely hard to anticipate them, or any reactions following the event. When black swan events happen, they have a massive effect on the market, and sometimes on entire systems of trading.
When we talk about hedging we're trying to mitigate price risks that could otherwise cause substantial losses. In the normal course of business, we can plan for future events and structure our positions accordingly to take the best course of action.
Frequently these events will become the catalyst for major changes that try to prevent similar situations occurring again. While the nature of black swan events suggests you can't mitigate for the potential risks, companies can (and should) be running frequent stress tests on their positions to see just how far they would have to be stretched to cause major problems.
The LME Nickel Crisis
We don't have to go too far back to find an excellent example of a black swan event in metals. I'm talking about the LME Nickel Crisis in March 2022. I know it's been a while since the event and a few different people have written about it, for those of you who didn't do a deep dive, here is my take.
In March 2022, a Chinese nickel producer called Tsingshan had amassed a very large short futures position on the LME Nickel contract. They alleged that they were simply using this position as a forward hedge for their future nickel production, but many believed that their position was largely speculative in nature.
Unfortunately for Tsingshan, the LME nickel price began to rally beyond the price of their short position, which put them into serious negative variation margin territory, far beyond any credit lines that might have been on offer. Importantly, their variation margin started to exceed their ability to cash finance their open short positions.
Once market participants realized that this short position was vulnerable, liquidity in the nickel market dried up and the price started rising again, putting extreme strain not just on Tsingshan but also on the banks and brokers that were holding the derivative positions, since they were having to cover the margin without being reimbursed by Tsingshan.
An important note on the position Tsingshan had built. It was largely put on in the OTC market, not through exchange traded positions. OTC positions are, by their nature, a lot more difficult to monitor, partly why some counterparties prefer using OTC derivatives than exchange cleared futures. Unless they are being cleared through the exchange clearing house, they would not immediately appear in exchange data. By the time the LME realized the size of Tsingshan's true position (OTC + LME) it was too late.
The Spike to $102k
On March 7th, 2022, 3M nickel on the LME rose almost 100% over the course of a single trading day, from a previous close of $30,000/mt to a high of $55,000/mt. At this point Tsingshan's margin calls were in the multiple billions of dollars.
Unfortunately for the LME, at that point in time they did not have any circuit breaker in place that would have kicked in and stopped the contract from trading. A circuit breaker is named as such as once it is triggered, all trading is halted for a pre-determined amount of time. This could be 5 minutes, 10 minutes, or for the balance of the trading day depending on the market. Circuit breakers are usually in place in order to prevent markets from becoming disorderly, give the market time to calm down, in the hopes that when trading re-opens, prices settle.
Even more unfortunately for the LME, they allowed the contract to open back up at 1AM London time on March 8th. The nickel contract is not the most liquid contract that trades on the LME anyway, but at 1AM liquidity was basically non-existent given what had already occurred the prior day.
The 3M nickel price rose rapidly, gapping higher and higher. It was rising thousands of dollars per ton with each few lots that were traded until the price hit a high of $102,000/mt. At that point, enough alarm bells (and I assume telephones) had rung in London that the LME halted the trading of the nickel contract.
At 12:05pm London time, The LME made the decision to cancel all Nickel trades made on March 8th 2022 from the opening trade up until the moment of suspension. Their reasoning was that the market was disorderly and multiple companies, even potentially the contract itself may have faced extinction should those trades have been allowed to stand.
What followed was over a week of discussions at the LME, with several CAT1 LME brokers potentially facing bankruptcy due to margin payments they could not possibly make. China was not going to bail out Tsingshan so there was no government backstop coming.
During this time, if you wanted to price a physical nickel contract, hedge production or consumption, roll a position, you had no means of doing so on the exchange.
Even when the LME resumed trading on the nickel contract on 16th March 2022 with the addition of limit up and down circuit breakers, trading was not functioning. Everyone was trying to sell at the highest price allowed, with barely any buyers. Within seconds of market open the first lots were executed and the limit down circuit breaker was triggered, halting trading for the day.
This went on for 3 further days until the price dropped to levels of prior the initial rally on March 7th. At this point enough market participants were willing to actively trade that some semblance of normalcy returned to the LME nickel contract.
As you can see from the chart below, the volumes were non-existent for the 4 days after the contract resumed trading. Because the LME cancelled trades on March 8th, there is no price bar for that day. If there was, it would have extended well above the $55k/mt level shown on this chart. Once the price dropped below the low on March 7th, volumes saw a spike with traders clearing their order books. After that initial spike, volumes tanked again and remained depressed.
Daily price and volume chart for LME 3M Nickel Feb-April 2022
Aftermath & Rule Changes
There were some major consequences of this event:
The LME placed circuit breaker levels on all base metals that would trigger if the contracts had a price change of a certain percentage in either direction within a trading day. Currently 12% up/down for Ali and Cu, 15% up/down for all others metals.
As you can see from the chart below, the nickel contract took over 2 years to get back to the volumes it was trading on a daily and weekly basis prior to the March 8th event.
Brokers are ever more cautious about extending credit for variation margin given the possibility of default. Things have calmed down now but in the immediate aftermath of this event, some brokers were refusing to accept new short positions on certain contracts for fear of sudden rallies that would leave them exposed. Some brokers were also no longer willing to guarantee 2nd ring or Kerb close prices - their reasoning being that if liquidity suffered and total 2nd ring orders for example were higher than total lots traded on 2nd ring, they werenโt willing to risk losing money on those fills.
The CME and other exchanges saw increased volumes across the board, not just on nickel, as speculative traders lost some faith in the LME after trades made in good faith were subsequently cancelled. The LME has worked incredibly hard since that event to restore the trading community's trust.
To avoid further liquidity issues, from 16th March 2022 through to 23rd February 2023, the LME nickel contract was only open for trading from 8am London, instead of 1am London like the rest of base metals. From 23rd February 2023, LME nickel resumed its regular open time of 1am London.
Weekly price and volume chart for LME 3M Nickel October 2021-March 2024
Lessons for Traders
As you can see, black swan events can cause violent, dramatic shifts in price, positioning, and liquidity, extremely quickly. Trying to plan for complete unknowns is difficult, but making sure that all relevant departments have the knowledge, and the ability to react quickly is paramount to avoiding catastrophic failures. The next black swan wonโt look like nickel in 2022. But it will test liquidity, credit, and risk controls in ways we canโt yet imagine
How are you stress-testing your positions for the next black swan?
