Trading activity on the London Metal Exchange will be boosted by investors and high volatility this year, but volumes are unlikely to beat last year's record because producers and consumers are expected to stay away. The exchange saw volumes rising 22 percent to 113 million lots from 2007 as investors were attracted by limited supplies and firm Chinese demand pushing the benchmark copper contract to a record high of $8,940 per tonne last July. Since its high the three-month futures of the metal, used in power and construction, are down more than 60 percent on fears of a global recession triggered by a collapse in financial markets forcing liquidations across commodities. "It could be difficult to sustain the very big increase we saw last year," said analyst Kevin Norrish at Barclays Capital. Demand for metals, credit availability and hedge fund flows will be key factors determining the size of the volumes in 2009. But the decider will be hedging -- a strategy to minimise exposure to price risk -- by consumers and producers, which is expected to decline because of poor demand for metals. "Consumers are looking to lock in prices for the future but most of our customers cannot take large positions," one physical trader said, adding only a few customers had shown extra interest with metals prices hovering close to last year's lows. A hedge is a position established in one market in an attempt to offset exposure to the price risk of an equal but opposite obligation or position in another market. Few producers would be keen to sell far forward at these relatively low prices, but high volatility would push many consumers and producers to cover some of their price exposure. "You need to have the guarantees against those positions and it costs money," the trader said, adding trading was limited by the global credit crunch which was making it harder to finance any deals. Dugald Ross at Castlestone Management, an alternative asset manager, expects trading volumes to be down in every commodity market due to the reduction in the leverage of hedge funds. "Once the appetite for risk returns then we should see increasing volumes again ... (But) I would be very surprised to see any new volume records broken in 2009," he said. RETURN OF DEMAND AND RISK APPETITE Producers and consumers are expected to hold back from the market at least during the first quarter of this year and volumes will depend more on the investment community, analyst Stephen Briggs at RBS Global Banking & Markets said. "If there is a reduction it is going to be because there is less investor involvement," he said. The LME does not provide a breakdown of non-commercial versus commercial positions and hedge funds do not make public their investment statistics. Hedge funds, which were forced to liquidate investments as the global financial crisis escalated after the collapse of U.S. bank Lehman Brothers, are a main source of uncertainty. "The area where there is a lot of doubt is the hedge funds, particularly the macro-oriented or the commodity specialist hedge funds," said Barclays' Norrish, adding these players provide a lot of the intraday trading volume. LME traders said trend followers like Commodity Trading Advisors (CTAs) still showed firm interest, but with news such as Swiss bank UBS selling their base metals trading books to Barclays Bank Plc volumes would ease. OVER-THE-COUNTER VS EXCHANGE The financial crisis has increased volumes onto the LME from the over-the-counter (OTC) market and the five-year extension of far forward aluminium and copper contracts has fuelled interest. "We have been asked to move positions that were OTC to the exchange," analyst Robin Bhar at Calyon said. The LME is using LCH.Clearnet as its clearing house acting as a guarantor, whereas an OTC market is principle to principle which means if a bank goes under the contract defaults. "I think we have seen the bulk of it, but any future deals will be more likely to be done on exchange rather than OTC given you can trade out to 10 years," Calyon's Bhar said.

Source