Russia is the gorilla in the room: It is a major exporter of many commodities from natural gas to wheat

"Is the canary in the nickel mine this time?

Much of the financial world -- and many commodity producers -- are wondering the same after an uncontrolled leap in nickel prices left the world's largest nickel producer struggling to satisfy billions of dollars of margin calls from big banks last week.

Future prices for the silvery-white metal, which is used in stainless steel and batteries, have been on a tear. They hit a record $100,000 per metric ton last Tuesday -- two days earlier they had been trading below $30,000. Worries about reduced supply from Russia, which is a major nickel producer, kicked off the chaos. But the more proximate cause was a short squeeze in the futures market, when traders trying to cover their short position led to others doing the same, creating a vicious spiral. China's Tsingshan Holding, the world's largest nickel producer, is on the hook for billions of dollars in trading losses while the London Metal Exchange suspended trading in nickel futures.

Nickel is a relatively small market, and after Tuesday's trading halt Tsingshan and its creditors, including JPMorgan Chase and Standard Chartered, are in negotiations on additional credit lines, potentially backed by the company's nickel and steel assets in Asia.

But the problem is that nickel may not be the end of it.

It is common for commodity traders and miners to use futures to hedge their exposure and lock in prices. But when prices swing so wildly, there can be mismatches in cash flows as the traders have to pose additional collateral. Asian coal prices also experienced swings in recent days -- nearly doubling in late February and early March before giving up some gains -- as have aluminum prices and wheat prices, to say nothing of the swings in crude oil. No one knows exactly what lies ahead for commodity prices but the idea that Tsingshan is the only company with big hedges that could go wrong might prove optimistic.

And the sanctions create extra uncertainties: Is it kosher to buy any Russian commodities, even ones hitherto spared by sanctions? What used to be routine seems riskier now. Even before the U.S. said it would ban imports of Russian oil and gas, traders were staying away from them: Urals crude has been trading at a big discount to benchmark oil prices.

Credit Suisse strategist Zoltan Pozsar has highlighted some obvious parallels to previous crises when the sudden repricing of another asset class -- mortgage backed securities -- led to massive trading losses and hard-to-suss counterparty risk. "Russian commodities today are like subprime CDOs were in 2008," he wrote in a note in early March.

As commodity traders dash for cash and lenders start to worry about counterparties' exposure, that could in theory start to put pressure on borrowing costs more generally. Russia is the gorilla in the room: It is a major exporter of many commodities from natural gas to wheat.

Commodity-related financial chaos may not prove nearly as destructive as the U.S. subprime explosion, but more big cave-ins could still be ahead." [1]

 

1. Worry About a Wooden Nickel Spreads
Wong, Jacky.
Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 15 Mar 2022: B.11.