Terror Trading?

On December 4, two law professors, Robert J. Jackson, Jr of NYU and Joshua Mitts of Columbia, issued a pre-print study (i.e., not peer reviewed) entitled Trading on Terror? In the Introduction, the authors write:

On October 7, 2023, Hamas launched a devastating terrorist attack on Israel, a tragedy with consequences we are only beginning to comprehend. But days before the attack, traders appeared to anticipate the events to come: on October 2, short interest in the MSCI Israel Exchange Traded Fund (ETF) suddenly, and significantly, spiked. And just before the attack, short selling of Israeli securities on the Tel Aviv Stock Exchange increased dramatically. While many investigating how the Hamas attack was financed have focused on cryptocurrency…, to our knowledge little attention has been given to trading in securities markets in advance of October 7…

In short, the study strongly suggests that Hamas front ran the attacks.

Needless to say, the press and social media jumped all over the story, claiming that Hamas made “millions” (in some reports, $859 million) from the attack, or even “billions” (but neglected to say that it was billions of Israeli Shekels, or something).

But how much did they really make (if they were even behind the trades in the first place)? Well, here’s where it gets interesting. Very soon after issuing the paper, The Tel Aviv Stock Exchange refuted the initial claim by Jackson and Mitts that traders made $859 million in profits on a 4.43 million share Bank Leumi short position. It seems that the authors made a fundamental factual error in their initial analysis, in that they used the wrong currency to calculate gains. Oops!

The possible gain from the Bank Leumi short trade was then corrected from $859 million to $8.59 million, two decimal points to the left and only 100X smaller. That’s a big change, and an embarrassing one. Kudos to the authors for acknowledging the fault and quickly issuing a correction. But, “pre-print release” or not, the $859 million figure, almost a billion dollars, fails any potential smell test and should have been reviewed with a fine tooth comb before the study was made public. Corrected or not, the original figure stuck with the press and will provide ample fodder for conspiracy theorists for years to come.

Apart from that, reporters for the Financial Times Alphaville, and others, have pointed out that the central premise of the authors’ conclusions, unusual volumes in the MSCI Israel Exchange Traded Fund, individual issues, and options, are flawed as well. First, the study’s short volume data comes from FINRA, and is therefore incomplete. In addition, short interest indicates a spike in September, a full month before the attack, and then decreases sharply before the end of the month. Second, and as the FT authors point out and give several examples for, large block trades in options do not necessarily indicate a conspiracy.

Without doubt, Trading on Terror makes for an interesting read, but suffice it to say that many of the paper’s conclusions have been called into question. I will leave it up to you to sort through the details and determine what’s true and what’s not. Alternatively, you can wait for the regulators to sort it all out and issue their conclusion (if they even look into it). For retail investors, there are at least two lessons to be learned:

1. A healthy degree of skepticism, especially when it comes to seemingly outrageous performance claims, is always merited.
2. More generally, beware of preconceived notions. Just because you want something to be true and it sounds “right,” doesn’t make it so.

Nickel: A Valuable Lesson, Again

For those of you that follow commodities, you might remember the crazy short squeeze in nickel that occurred on the London Metals Exchange (LME) back in March 2022. Short squeezes in commodities aren’t that rare, but in this case, the exchange’s reaction was unusual, to say the least. Although nickel is a relatively niche commodity and market, the lessons learned are valuable for all mainstream investors.

Without rehashing the whole sordid affair, a large Chinese nickel trader (Xiang Guangda, founder of Tsingshan Holdings, known as “Big Shot” — no kidding) tried to swamp the market with nickel. Unfortunately for him, the war in Ukraine broke out and the prospect of impending shortages drove the price higher. Smelling blood, a vicious short squeeze resulted. On Friday, March 4, 2022, nickel settled at $28,919, then blew up to $48,078 the following Monday, and then finally topped out at $101,363 the next morning. The exchange then suspended trading.

With billions in margin calls against LME brokers and dealers, the exchange faced an existential threat and had to do something to maintain its integrity. Historically, exchanges can do a variety of things if their viability is threatened. During times of war or economic calamity, they might shut the exchange for a few days to let things cool off. Alternatively, they may institute a liquidation-only market in which traders are only allowed to liquidate existing positions but not allowed to add any new ones. There is certainly ample precedent for both.

But then the LME did something extraordinary. As I wrote in my original article,

‘In one of the greatest “do-overs” in financial history, the LME decided to cancel all trades that took place on Tuesday morning, the entire session, about 9,000 trades, and act like it never happened _. The previous day’s settlement, $48,078, was then the last prevailing price until the market reopens. Needless to say, the traders, brokers, and hedge funds that traded on Tuesday morning and made money were more than a little unhappy, and rightly so. These include Goldman Sachs, AQR Capital, and other well capitalized traders, not individual investors that the exchange could easily ignore. As is usually the case in such circumstances, time for everyone to lawyer up.”_

And that’s exactly what they did, they sued in the UK on the grounds that the exchange had acted unlawfully. At the end of last month, the high court issued its judgement, and it wasn’t a shocker. As the LME put it, “__the court ruled in favour of the LME and LME Clear on all grounds, confirming that the actions taken in the nickel market in 2022 were lawful, rational and in accordance with the LME’s rules. The judgment recognises the LME’s obligation to maintain orderly markets and its powers to intervene to this end, including by cancelling trades.”

So that’s that. An interesting story, but what can retail investors learn from all this? Again, as I wrote previously:

• Your trades are only as good as the exchange in which they are executed.
• Exchanges are a business, not a public service, and will act in their members’ interest every time, regardless of reputation.
• Trading on an exchange is not exactly a free market (but close). As a trader, you are subject to the exchange’s rules and regulations, agree with them not — it’s their ballpark.
• The chance of exchange intervention during market disruptions, for any reason, are high; they can, and will, do anything to maintain an orderly market and, ultimately, their financial integrity and survival. Short-term considerations will prevail; they will deal with the long-term later. Retail traders can get hurt in the crossfire.