What is the current deal with commodity trading?

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By Sylvain Thieullent, CEO, Horizon Software

The London Metal Exchange (LME) trading ring has been the noisy home of metal traders who have been buying and selling for over a hundred years. It is the oldest and largest metal market in the world and is home to the last auction hall. Recently however, the secular commercial ring, despite having been closed during the pandemic and, last month, the LME announced that it will have six more months and that it is taking steps to improve its e-commerce. This news is part of the growing commodities narrative of a shift to e-commerce that is bubbling beneath the surface.

Something is certainly moving in commodities. The crisis has affected different commodities differently: a weakened dollar and rising inflation risks bode well for some commodities, with precious metals being very attractive, as evidenced by gold reaching historic highs. Oil, on the other hand, has had a difficult year and experienced record lows due to the price war between Saudi Arabia and Russia. It has been an eventful year, and now the prices seem poised to skyrocket. While a recent Goldman Sachs analyst report predicts a bullish commodities market for the coming year, the firm expects its commodities index to rise 28%, led by energy (43%) and precious metals (18%).

Therefore, it increasingly seems that 2020 is turning out to be a turning point for commodities, and it is likely that the coming years will bring a significant transformation. And while this development may have been forced in part by the coronavirus, these changes have been accumulating for some time. Raw materials are one of the latest strengths to embrace e-commerce; FX was the first to take the plunge in the 90s, and since then stocks and bonds have integrated technology into their infrastructure, which has continued to progress.

The slow adoption of commodities can be explained by several truths: volumes are lower and there is less liquidity, and instruments are generally less exotic, which essentially means that it has not been essential. for them to develop such technology – at least not so far. This means that, for the most part, the technology in commodity trading is a bit outdated. But that is about to change. Commodity trading is about to take steps to reach the levels of sophistication of trading as we see in other asset classes, with automated trading and algo becoming more and more important.

Yet, as commodity trading institutions modernize their systems, they will begin to discover the extent of the work to be done. It is not easy to upgrade the functioning of an entire business community, so there is a lot to do in these massive organizations. This requires a massive technological overhaul, and exchanges and trading companies need to be careful in their approach, carefully establishing a holistic, step-by-step implementation strategy, preferably with an agile V-model approach.

The workflow should be upgraded at every step to ensure a smooth end-to-end trading experience. Thus, replacing the infamous ring, these players will seek to transform key elements of their trading infrastructure, including reengineering match engines and improving communications with clearing houses.

However, these changes extend beyond technology. For commodities players to successfully transform their community, exchanges must have highly skilled technology and change the very culture of trading. All of this is currently being done in a containment context, which makes things much more difficult and may slow down implementation.

What is clear is that the coronavirus has definitely acted as a catalyst for commodity reform. This is a foreshadowing of what lies ahead for the commodities trading infrastructure because in a few years commodity trading could be very different from what it is today, and the ring of trade relegated to history.

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