FOCUS: Record-low aluminium stocks leave LME spreads vulnerable to more backwardations

With available stocks at record lows, aluminium spreads on the London Metal Exchange are increasingly volatile.

More than 200,000 tonnes of aluminium was freshly canceled on the exchange during July across Europe and Asia at a time when a significant backwardation took hold of the spreads.

The benchmark cash/three-months was at $50 per tonne backwardation on July 16, with all the nearby spreads also in backwardation and the July/August spread at $68b per tonne on the same day.

The cash/three-month spread swung back into contango in the afternoon of July 23 and was at $20.75 per tonne contango on Thursday August 2.

But aluminium stocks on the LME total just 850,500 tonnes as of Thursday and the multiple cancelations of stock during the period of backwardation has left numerous traders uneasy about the possible return of the backwardation in the near future.

“Canceling 100,000 tonnes of metal when the backwardation was so fierce, it was absolute insanity,” a European trader said. “It wasn’t in [keeping] with the normal cycle, but nothing during the most recent backwardation was normal. It is not the first backwardation, or the last, but one of the worst.”

"Unless there is a change of flows the continued drawdown of LME stocks will create enough pressure for the markets to run in their own direction and ignore all the short-term twists, turns and presidential tweets,” Malcolm Freeman, Kingdom Futures, said.

Defying the cycle
The regular spread and stock cycle has been disjointed on the exchange in recent months. Previously, a significant backwardation would entice people to deliver metal onto the exchange to push the price back down.

The delivery of metal would then swing the spreads back into contango and people begin to pick metal back up because it is profitable to hold on the spreads, leading once again to lower stocks.

But this has not been the case during the aluminium backwardation this summer. With on-warrant stock levels below 900,000 tonnes, it leaves the spread vulnerable to more dramatic swings.

“I wouldn’t be surprised if people change the way they do things – why on earth would you stockpile metal and hold so much if the spreads can swing to backwardation so easily,” a second trader said.

“For a physically delivered contract, there is not much physical metal sitting the warehouses. If we keep seeing deliveries out and cancelations then the backwardations will return sooner rather than later,” a third trader said.

While the spreads remained in significant backwardation, there was great pressure on the European premiums with distressed sellers liquidating at low levels to avoid holding metal during the backwardation.

Metal Bulletin’s Rotterdam duty-unpaid aluminium premium was at $90-100 per tonne on June 28, and when the backwardations began to widen by the middle of July the premium was down to $70-90 per tonne.

“The premiums always get put under pressure because people get caught with their metal and if the backwardation is over $15 per tonne that can get very painful,” a fourth trader said.

Zinc following the trend
Zinc spreads on the LME are currently in a large backwardation while stocks sit at low levels – the benchmark cash/three-month spread was most recently at $55.75 per tonne backwardation with the nearby cash/August spread at $42.15b per tonne.

LME zinc stocks have been falling consistently for the past five years – since January 2013 zinc stocks have fallen 80% with on-warrant levels most recently at just 215,250 tonnes.

“I believe the LME market is prone to more sharp rolls, which is a systematic result of a situation of low on-warrant material compared to off-warrant [particularly in copper and zinc],” Oliver Nugent, analyst at ING, said.

“There’s also a strain on the availability on ingots. Add that to a deficit market, and I expect to see more sharp rolls in the future,” he added.

Zinc spreads are yet to turn back into contango and some market participants see the backwardation lasting for a number of months.

“The stocks in warehouse movements has almost stopped having an effect on the price – and there doesn’t seem the ability to swing it back into contango straight away,” a market source said.

There remain significant dominant position holders in zinc on the LME, with one market participant holding 80-89% of warrant cash positions and one participant holding 50-79% of warrant tom/next positions.

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