LBMA Precious Metals Conference 2008 - Kyoto
London Bullion Market Association
Phil Clewes-Garner, Chairman Our next speaker is Tim Gardiner. Tim is currently President and CEO of Mitsui & Company Precious Metals Incorporated with the responsibility for Mitsui's precious metals operations in New York, London and Sydney. Tim has almost 20 years’ experience in the market, primarily with Mitsui, but did spend four year in the mid 1990s with JP Morgan. Tim received an undergraduate degree from Queens University Canada in 1983 and an MBA from IMD Switzerland in 1989. He now lives in New York with Nancy, his wife of 22 years, and their four children.
Futures Market in the US and Japan: Where Next? Tim Gardiner President and Chief Executive Officer, Mitsui & Company Previous Metals Incorporated
I.
Preamble
It is my sincere honour to be talking today in front of such a distinguished audience. I was very pleased to be asked to contribute to the ‘trading trends’ portion of the conference, together with Philip, Gerhard and Ross. I estimate that we have approximately 100 years of trading experience between the four of us. We have experienced some wild markets over the years. I feel this is beginning to numb my sense of apprehension. For some reason, commentators say that the months since we met in Mumbai will be written into the economic history textbooks. As an example, a week ago, I received the following email commentary on the markets: ‘Forget January; forget Société Générale. This will go down in history as one of the craziest, if not the craziest week in the history of the financial markets.’ What are they going to say about this week? For me, it seems like just another year. I must admit, it has been a strange one.
II.
History of the Markets
Trading in precious metals is a great business because it straddles the commodity and financial worlds. It is also a relatively small and specialised market. One of my only regrets is that I did not keep a diary of past events. Does everyone remember when palladium was dubbed ‘unobtainium’? You had to ‘sweat out’ each day to find out if short-term metal was available on lease. We still have a Reuters conversation at Mitsui New York of our lending out of palladium for one day at an interest rate of 250%. Just a couple of years ago, platinum was slowly but surely moving through the $1,000 barrier and young hotshot option traders were happily selling what seemed like easy money with three-month $1,400 calls, only to have the metal rally to the strike price. Holders of the options then told the Swiss clearers that they might want to take allocated delivery. This was 120% option volatility with no offers. Gold and silver had been virtual commodity doormats during the dotcom era on the front page of the newspapers. With the meltdown of the past few weeks, I am sure some would want to forget about the long liquidation, but what a grand performance by the precious metals. We have been part of an incredible evolution. Through it all, the consistent dominant trading tool has been the precious metals futures markets. In my opinion, the proportion of precious metals
28 -30 September 2008
1
LBMA Precious Metals Conference 2008 - Kyoto
London Bullion Market Association
trading taking place on the futures markets has never been as large as it is today. The futures industry in general has never been as healthy. According to the Futures Industry Association, volumes of futures and options traded on the 61 worldwide exchanges surged 17% in the six months to June 2008 versus the same period in 2007. The most active precious metals contract, NYMEX Gold, was up a staggering 76%. There has been huge change.
III.
An Example from Trading Places
In 1983, a few years before I began with Mitsui in London, a funny film was released called ‘Trading Places.’ It starred Dan Ackroyd, Eddie Murphy and Jamie Lee Curtis, and told the story of how a snobby Ivy League graduate named Louis Winthorpe III and a wily street con named Billy Ray Valentine turned the tables on veritable commodity brokers Randolph and Mortimer Duke to win big by shorting frozen orange juice futures. Of course, this was done through the use of inside information. To give you a flavour of what futures trading was like until just a few years ago, here is one of my favourite scenes. This is the moment when Louis and Billy Ray enter the trading floor before starting to short the contract; thereafter buying it back after the bearish news hit the pit. [An extract from Trading Places is shown.] LOUIS WINTHORPE III: Well, this is it, the last bastion of pure capitalism left on earth. Here in New York they trade everything: gold, silver, platinum, heating oil, propane, cocoa and sugar, and of course, frozen concentrated orange juice. The people on the phones are taking orders from brokerage houses all over the world. The runners then hand those orders to the traders in the pits. They are trading cotton over there; that is the silver pit. The Duke’s trader is going to be buying like crazy right from the opening. BILLY RAY VALENTINE: He will be waiting until he drives the price up. LOUIS WINTHORPE III: Right. I cannot wait to see his face when they broadcast that genuine crop report. OJ trading opens at nine. BILLY RAY VALENTINE: Let us go kick some butt! [The extract ends] Needless to say, the boys were successful in their strategy and they quickly retired to a tax-free Caribbean island far away from commodity futures trading and lived happily ever after.
IV.
An Example from a Current Trade
25 years later, and where are we today? This is a clip of one of our traders, Jim Maloney, taking an order from one of our marketers, Steve Scacalossi, and executing a 20,000 ounce gold sale. As a disclaimer, please remember that we are metal trading professionals, but amateurs in film-making. We filmed this only eight days ago. You can also hear where the gold price was then. [An extract is played] PRESENTER: Good morning, Kyoto. I am standing in the Met Life building, in Manhattan. This is Mitsui New York’s metals trading desk. We have base metals at the end, which of course has gone electronic. I wanted to show you what has happened in the precious metals market. These
28 -30 September 2008
2
LBMA Precious Metals Conference 2008 - Kyoto
London Bullion Market Association
are our three precious metal traders. Among them, they have a total of 20 screens in front of them so that they can monitor the various electronic systems, including the futures market. Jim is going to give you a short demonstration of what he does with the electronic trading. In the past, we would be using the telephone. STEVE:
Gold on 20,000?
JIM:
755 at 56.
STEVE:
Sell 20,000 please.
JIM:
Sold 200 on the electronic.
STEVE:
Thank you.
[The extract ends]
V.
The End of Open Outcry Trading
What you saw in both video clips were futures contracts being traded. I have to admit that I miss the ‘open outcry’ of NYMEX COMEX and the clap of the gekitaku when prices were fixed. I would like to thank the Tokyo Commodity Exchange (TOCOM) for lending me this original gekitaku clapper. I understand it is the last unit that remains from the days that ended in 1991. One of my most vivid memories of visiting TOCOM in 1989 was seeing the crazy Japanese TOCOM traders, and then this clapper being suddenly cracked. Here is an image of TOCOM in full swing. The exchange stopped ‘open outcry’ trading in 1991. Open outcry was a fun part of the business with brokers giving individual commentary and flavour of what was happening on the floor. There were some real characters involved. While OTC traders treated the futures pits as ‘just another counterparty for liquidity,’ it was unique in its information flow and execution.
VI.
The History of Electronic Trading
We joke that Mitsui’s TOCOM traders are excellent Nintendo players. How did we get to the electronic trading of today and gazing at banks of screens to manage positions? In my opinion, there were three factors that linked together. Firstly, there was a reduction of flow across OTC market maker desks. We have already heard Gerry talk about the importance of loco London and Zurich marketplaces, but by the end of the 1990s, traditional business was beginning to dry up as producers reduced hedging transactions, and overall interest in precious metals declined. The equity markets and the Initial Public Offering (IPO) dotcom start-ups were the places to be. Credit Suisse and N M Rothschild were both market makers at the time. They left the OTC market completely. Several participants scaled back their trading personnel to reduce overheads, with many choosing to centralise traders in Europe to cover the time zones of Asia Pacific and America. I remember agonising about how I was going to attract fresh blood to Mitsui’s precious metals business, let alone not lose my experienced personnel. Naturally, the reduced liquidity caused spreads to widen in the OTC market, which allowed the brokerage fraternity to really build a presence and profitability in the market.
28 -30 September 2008
3
LBMA Precious Metals Conference 2008 - Kyoto
London Bullion Market Association
Just as traders became lazy and let the brokers do more of their work for them, the futures exchanges began expanding electronic trading. Contact amongst precious metals participants became even more impersonal. As previously mentioned, TOCOM had already done away with its ‘open outcry’ system. COMEX then sold its electronic trading rights to NYMEX and 24-hour electronic trading in precious metals futures was born. The world’s clearing houses aggressively marketed this new type of trading so that previous OTC clients suddenly had terminals on their desk giving them direct access to the futures contracts. I can still remember a visit to Dubai a couple of years ago. I was stunned to see so many traditional names trading electronically. The reason: perceived better prices, execution and transparency.
VII. The Current Situation of the Futures Industry So far this morning I have painted a very rosy picture of the futures industry. Currently, however, investors may have other ideas. This slide shows a chart of the monthly performance of NYMEX and Chicago Mercantile Exchange (CME) shares since 2006. I have also charted the Dow Jones Global Exchange Index, which provides a measure of all publicly traded exchanges and trading floors. As you may be aware, CME Group bought NYMEX holdings at the end of August. The world’s dominant futures exchange became even bigger. It must now get down to the business of pushing even larger volumes of contracts through its trading platforms. After explosive growth, it is clear that enthusiasm for this sector has lost its upward momentum. Investors have every right to question where the longer term growth rates for futures exchanges will settle. As an aside, I expect consolidation in the futures industry to continue.
VIII. Future Outlook for the Futures Industry We now look to the future for the futures markets. Ross will shortly be giving his overview of the various electronic platforms available to the market participants. Certainly the growth of these platforms will influence the futures industry. The popularity of exchange traded funds, for example, ‘Ticker: GLD’ on the New York Stock Exchange (NYSE), will also impact the relative volume of futures traded. Investors finally have access to precious metals without using futures contracts or taking quasi positions through precious metals producer equities. This slide shows a quote from commentator-trader Dennis Gartman last week, in regards to precious metals: ‘We are witnessing a diminishing of the importance of the futures markets and an increase in the importance of the ETF. This we understand because we have watched ourselves become almost wholly involved with the ETF, seeing it as a better vehicle for speculation and accumulation of a stable gold position over time. The public has become enamoured of the ETF and we expect this process to continue over time.’
IX.
Closing Comments
In my opinion, the precious metals futures markets will stay healthy going forward, if they stay disciplined in promoting those attributes that got them to where they are today: In the face of so much competition to attract the next click of the keyboard, futures exchanges must keep spending marketing dollars to fight against market share being eroded. If the exchanges get complacent in the wake of the sensational profits they are earning from the surge in trading volumes, it may be difficult to gain the status enjoyed today.
28 -30 September 2008
4
LBMA Precious Metals Conference 2008 - Kyoto
London Bullion Market Association
Exchange personnel need to be constantly innovating products according to the needs of market users. The successful launch of the Shanghai gold contract is a great example. The industry must be keenly aware that execution costs are going one way: down. As efficiencies are recognised, the cost of trading futures needs to fall in line with the competition. Looking at the overall cost of trading futures, initial and variation margins need to stay at prudent levels. Excessive margining may the biggest threat to a robust and healthy futures marketplace going forward. Credit risk is so important in today’s environment. Through margining and the setting up of clearing house guarantees from member clearing firms, the integrity of the futures market has to be maintained. Any perceived default risk in the futures system will lead to a massive reduction in volumes. The market must remain transparent and, wherever possible, must be a benchmark for the pricing of transactions. The industry must also be careful with the rise of the broker community and the perceived transparency that brokers bring to the OTC markets. The futures market must do all of the foregoing if it is to maintain its liquidity and depth. This is most important. Open interest cannot be allowed to fall, relative to the competition. After all, these markets make their money from turnover, and liquidity breeds liquidity.
X.
Summary
In summary, you could say that the futures markets have seen their share of technological advances in the 25 years since Dan and Eddie wiped out the Duke brothers in the frozen orange juice pit. I still maintain that the open outcry of the exchange floors was an important part of our business, but I will accept the fact that going electronic was an efficient and effective development. The futures industry is in the best shape it has ever been in. Volumes have continued to increase. I admit that recent events have put the brakes on volumes to a certain extent. However, it is very important for us all to remember that a healthy futures market goes hand in hand with the strong OTC market. What our futures market industry must not do is rest on its laurels. As Ross will talk about next, predatory electronic platforms lay in wait to take market share.
28 -30 September 2008
5
