The Hunt for Clues Begins With a Kick

(Bloomberg) — The revelation that about $2 million of “nickel” on the London Metal Exchange was actually just bags of stones has thrown a spotlight on the sprawling web of warehouses and metal stashes underpinning the billions of dollars of derivatives traded daily on the LME.

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Over the past week, warehouse staff from Busan in South Korea to Genoa in Italy have rushed to check tens of thousands of two-ton bags of nickel – in some cases, by literally kicking them.

The LME advised warehouse operators to wear steel toe-capped boots for safety, one person who received the instructions said. The rule of thumb: If it hurts when you kick it, it’s probably nickel.

The mass inspection, which also included more carefully calibrated checks like weighing and scanning the bags, came after the LME last week announced it had discovered “irregularities” in nine nickel contracts. Bloomberg has reported that the contracts – now invalidated – belonged to JPMorgan Chase & Co. No other issues were found across the LME’s global network of warehouses, the exchange said on Thursday.

Attention will now turn to the question of how the bags of stones could have been bought and sold as nickel on the LME – long viewed by traders as the one place where they don’t need to second guess the contents of their cargoes.

The first sign of trouble came after some of the bags of “nickel” were bought from an LME-registered warehouse in Rotterdam by two trading companies, Trafigura Group and Stratton Metals. When the bags were delivered out, their weights didn’t match the paperwork. Inside, rather than nickel briquettes — which look like lumps of charcoal for barbecuing — the bags had stones instead.

When the rest of the Rotterdam warehouse was searched, the bags underlying nine LME contracts belonging to JPMorgan were also found to contain stones.

There are two possible explanations: either the bags were already full of stones when they were first delivered into Access World’s Rotterdam warehouse, or someone sneaked into the warehouse to steal the nickel.

Read: LME Rocked by New Nickel Scandal After Finding Bags of Stones

Access World is leaning toward the second theory, according to people familiar with the matter, because it has a record of the material being weighed when it first entered the warehouse.

It’s far from the first time the metals industry has had to deal with scandals and theft, and nickel’s high value makes it a favorite of fraudsters. Just last month, Trafigura said it had been the victim of a “systematic fraud” whereby it spent some $600 million on cargoes of nickel that turned out not to contain the metal. (Trafigura has said the LME saga isn’t connected to its legal case over the alleged fraud.) In 2017, banks lost over $300 million after discovering fake warehouse receipts for nickel stored in Access World warehouses in Asia — in that case, outside of the LME’s network.

Metals traders joke about how the oldest known written complaint – on a clay tablet housed in the British Museum – details a deal gone wrong over substandard copper.

But in today’s world, the LME’s system is the one place where metal is assumed to be unquestionably safe. The exchange’s contracts, which are the global benchmark for industrial metals like copper, nickel and zinc, are backed by physical metal in the network of warehouses around the world.

While the vast majority of trades on the exchange are purely financial transactions involving hedge funds seeking to bet on the price of metals, or producers looking to hedge, anyone who holds a contract to expiry receives a parcel of metal in an LME-registered warehouse. The whole system relies on warehouse companies to vouch for the metal they have loaded in when they produce an LME “warrant” – a warehouse receipt that can be delivered against an LME contract.

“Elevated prices on base metals make them a natural target for fraud and theft,” said Simon Collins, former head of metals at Trafigura and the CEO of digital trading platform TradeCloud. “Commodity companies need to protect themselves via stringent procedures around people, processes and technology.”

Access World has said it believes the nine warrants suspended by the LME were an isolated case, “specific to one warehouse in Rotterdam.” A promotional video for the company’s facility in Rotterdam’s port area shows a brightly lit warehouse filled with stacks of shiny metal, as well as numerous security cameras.

Read: JPMorgan Owned the LME ‘Nickel’ That Was Actually Bags of Stones

One headache for investigators is that it’s far from clear when any nefarious activity took place: the material was first delivered into the Rotterdam warehouse several years ago, according to people familiar with the matter.

It may have gone undetected for years, because of a quirk specific to the nickel market. Unlike aluminum and copper, which are kept in neat stacks in warehouses, most of the nickel in the LME is in the form of briquettes in bags. Warehousing and shipping companies typically don’t look inside the bags, checking only that the seals haven’t been tampered with. They issue warehouse receipts on what is called a “said to contain” basis – meaning they cannot vouch for the contents.

The number of problem bags was small, affecting only a few dozen tons of nickel. But the news that just a few of the LME’s nickel contracts were compromised has led traders to reconsider the assumption that LME registered metal is always perfectly secure.

The price of nickel for immediate delivery plunged to the biggest discount to three-month futures in 15 years this week, in a sign that some traders were suddenly wary of taking delivery of LME nickel contracts.

For the LME, the warehouse issue represents yet another headache as it wades through the fallout of its last nickel crisis a year ago. It also comes as the exchange is finally preparing to resume regular trading hours in nickel — now scheduled for Monday — when the market will open during the Asian day for the first time since early March 2022.