The LME Nickel Crisis: Basis Risk and Market Dislocation

The LME nickel contract experienced significant volatility and market dislocation last year, with daily price increases of 50 to 100%. The crisis was caused by a Chinese nickel producer trying to hedge his price risk with futures contracts, but as prices moved, his short position became out of the money, resulting in a potential loss of $2 billion. The mismatch between the futures market and physical markets in Asia, including differences in delivery standards and timing, created basis risk. This issue is not limited to the nickel market, but also affects precious metals like gold. The solutions include creating pools of liquidity through regional exchanges with matching delivery standards and contract norms.