In LME warehouses certainty is possible because metal stored in warehouses belongs to the owner of the document or receipt, which is issued, by the warehouse company when the metal is first placed in the warehouse. A document of possession, issued by the warehouse company, for each lot of LME approved metal held within an LME approved facility is called “LME Warrant”. The warehouse companies can only issue warrants if they are satisfied that the metal conforms to the specified covering quality, shape, and weight as defined by the special contract rules of the LME, and is of brand or production of a producer named in the LME-approved list. In fact, a relatively small percentage of LME contracts result in a warrant delivery, as majority of contracts are used as a hedging tools, which are bought or sold before expiry date or delivery date.

However, London Metal Exchange does not run or operate its own warehouses. In fact it approves geographical locations globally as good delivery points and then approves warehouse companies, which operates within those locations provided with specific facilities. Now, these approved warehouse companies set fixed rents, which is charged on yearly basis against the storage of LME- warranted metal. These rent charges are published by the exchange and become effective on the beginning of every new financial year i.e. 1st day of April every year. Also if there are any changes to the costs of the rent, in that case warehouse companies has to inform the exchange by giving notice, further which is given to LME members at least three months prior to the operative date.

Request for opening warehouse in new location is led by the industry and formal application must be made to the exchange by the port authority who will be asked to demonstrate that the proposed delivery point is in an area of net consumption of the metal and it is capable of becoming a natural, logistically sound mode for the passage of metal which is to be delivered on final consumption point. The number of shipping lines servicing to the port, working practices at the port and the rail and road infrastructures are also taken into account when consideration is given to the location. LME-listed warehouse companies are independently owned, and only substantial companies are considered for approval.

The approved companies or the warehouse companies holding LME warranted metal are subjected to get audited at least once in a year by an independent audit firm. Other than these audit firms, the LME executive staff also enforces a program of spot checks on all significant warehouses during the course of the year. LME has maintained its position worldwide in providing a good, representative pricing mechanism.

Consequently, there is an ongoing study in LME on setting up the new warehouses in existing as well as non-existing countries. The study is based on the policy that warehouses should be set up on those locations where there is net consumption rather than production. This helps to avoid undesirable dumping of the metal by the producers. The expansion of the delivery network is essential to the LME for long term to encourage consumer confidence. Also, the greater the network, greater will be transparency and further more useful are LME stock reports for the investorsthe market. Receivers of LME-warranted metal must be aware, that warehousing is a complicated business, logistics of which need to be done by careful planning as there may be other parties also which can wish to take metal from the warehouse at the same time.

Therefore, a receiver has to maintain close connection with these warehouses to ensure that satisfactory delivery schedules are achieved. As a result, deliveries that do take place, either in or out of warehouses, strongly reflect the physical market demand and supply. Because of this, the LME’s daily stock reports play a major part in the assessment of prices quoted on bourses. These daily reports are required to report LME by the warehouse companies at 16:30 hours (U.K time) each business day. After that, these stocks are published at 09:00 hours (U.K. time) on the following business day. They are published via the LME’s vendor feed system, which provides information to international quote vendors.

Many of the participants in the market for base metals would probably expect a strong negative relation between LME warehouse inventories and 3-month forward prices over long periods of time. In other words they would expect lower inventories to be associated with higher prices, and vice versa. However, the existence of a strong negative relationship between inventories and prices does not guarantee the profitable trading signals always as other economic factors also determine the prices. But somewhat analysis suggests that the market more often is slow to react, than not, to significant changes in LME inventories for most of the base metals.

However, it is possible to construct fairly simple yet profitable inventory based signals. This will get clearer from below mentioned charts, which shows the relation between movements in stock position and prices. Below mentioned charts shows the scatter diagrams for the 3- month forward prices of the four LME base metals against their respective LME inventory levels using weekly data from June 30th 2008 to August18th 2008. For e.g.- if we look at the copper chart, it can be seen that there is continuous rise in inventory level in a given interval of time and reacting to that the prices are taking downward direction, which confirms that there is a negative relationship between warehouse inventories and prices. While in case of zinc, negative relationship is there but trivial change in prices can be noticed comparatively to change in inventory level, which signifies that this information is useful in the design of trading signal. In other words, it means that it is probably better to use percentage changes rather than changes measured in levels.

Base Metals
Prices (‘000 US$) vs. Inventory (‘000 tonnes)

Similarly, in following charts Lead and Nickel movements are also up to some extent proves a negative relationship between price movement and change in inventory level.

So from above study we have seen that one can take profitable signals from warehouse released data and definitely can generate profits out of it from both long and short positions, i.e. in both bear and bull markets and in both moderate and high volatility market. But also one has to take other factors into consideration because as mentioned earlier level changes in warehouse inventories can only helps in taking cues or signals and not definite call.