Mini is all the rage this season. At least it is on the now Hong Kong-owned London Metal Exchange (LME).
Three new mini futures contracts for aluminum, zinc, and copper are launching on December 1. Priced in Chinese renminbi, these mini contracts carry a big punch and have a few distinct advantages over their larger brethren.
Retail investors would be wise to explore this new option, but they should also take note of the implications.
You see, the Chinese want to move the U.S. dollar aside and make the renminbi the world’s reserve currency. And these new mini contracts are just a small part of their diabolical plan.
Tiny Is Taking Over
The size of each mini contract is just five metric tonnes (MT), smaller than the standard LME nonferrous metal contract, which is 25 MT.
And they have three distinct advantages over the traditional contract.
First, mini contracts are designed for the retail markets or smaller industrial hedgers that find the standard LME contract too large.
Second, they add greater liquidity to the industrial metals market, allowing more participants to trade. Greater liquidity means a heightened level of trading volume for global industrial metals, which is a good thing for the market’s participants. And while mini contracts already exist on the LME, none were traded in renminbi. This meant that prior to the launch of these hybrid minis, you had to put on both a metals trade and a renminbi trade. The minis facilitate this transaction by removing that additional step.
And third, the launch of any new financial instruments tends to create interesting arbitrage opportunities – in this case, between Hong Kong and other industrial metals futures markets around the globe, such as London, Singapore, and New York.
This window will likely narrow quickly due to the efficiency of currency and metals markets, meaning the mini-contract trend will far outlive the arbitrage.
The mini contract’s specifications are as follows:
The contracts will be based on the settlement prices of LME futures and will be settled in cash, not with physical metal like the standard LME contracts.
The final settlement price will be the Official Settlement Price published by the LME. This will be converted to the renminbi equivalent using spot USD/ renminbi pricing (published by the Treasury Markets Association in Hong Kong at 11:15 AM Hong Kong Time).
Also, it’s important for investors to note that the last trading day will be two business days before the third Wednesday of the spot month, and that the schedule will follow the Hong Kong Futures Exchange.
If the launch proves successful, down the road we could see minis in other metals – both industrial and precious – traded in renminbi.
The close ties with the Hong Kong Futures Exchange are not surprising, considering the Exchange now owns the LME. But mini futures do mark a change in China’s positioning of the renminbi in the world’s markets.
China Tries to Take the Reins
As I alluded to before, there are some interesting implications stemming from these new contracts as they relate to China and its role in international trade.
China’s dominance over metals trading became evident in 2012, when Hong Kong Exchanges and Clearing Ltd. gained instant access to commodities trading by buying the LME for the equivalent of $2.16 billion.
The transaction made sense, since China is the world’s largest consumer of industrial metals – representing approximately 40% of global consumption.
China has also been working to make the renminbi more competitive with the U.S. dollar. In fact, China seeks to make the renminbi the reserve currency of the world!
How will it try to do this? Well, China will continue to gradually open up its capital account, make offshore renminbi liquidity more easily available, and sign up more renminbi trading centers – it has opened two recently in London and Frankfurt.
On top of that, in March of 2014, the People’s Bank of China (PBOC) announced a historic economic policy shift. China realized that it needs to let its currency’s value be market determined rather than tightly managed, and thus the PBOC widened its band around the renminbi’s central value relative to the U.S. dollar from 1% to 2% in either direction.
This act created major volatility in the currency markets and in China’s capital flow and trade reserve levels, eventually leading to currency intervention by the PCOB.
But despite these efforts, the U.S. dollar will continue to be the world’s reserve currency because of three crucial characteristics: 1) It’s the most widely used and accepted currency around the world, 2) it is free floating against other currencies (unlike renminbi, which trades in a tight band against the U.S. dollar), and 3) it can be printed to increase supply in times of easy monetary policy.