Blowout in Chicago/London arbitrage has copper market looking to US

An arbitrage between two of the world’s main copper contracts has had the market chasing shadows over the week ended Wednesday July 28.

On July 26, the Comex active (September) contract traded at more than $300 per tonne above London Metal Exchange price levels for the month to date, in what was a record spread between the two contracts.

The massive premium came at the end of a month in which the Chicago prompt contract has consistently traded above the London value, and with the futures market pricing a gap between the two for at least a year.

But the unusual switch also reflected a growing market trend; investors globally were turning in greater numbers to the United States as the world’s main source of expected industrial growth, more than had been expected by a copper market that was still splintered by soaring logistics costs.

“There are two sides of the coin,” Citi metals analyst Oliver Nugent told Fastmarkets. “The US is tight, really calling out for incremental units, but you’ve also got it in juxtaposition with the LME, which in our view has been hit negatively by the costs of exporting [in every region].”

Shorts capitulate
The Comex contract has traded in the range of $50-100 per tonne above its LME counterpart since the beginning of June, but the spread leapt this week to more than $300 per tonne, hitting $350 per tonne on July 27.

The difference was exacerbated by market participants who were shorting the spread (betting that it would diminish) being compelled to cover their positions. This caused the price to rise through key technical levels on the Comex, according to several market sources who asked for anonymity when speaking to Fastmarkets.

“Given the volatile nature of the move, and the fact that copper traded against risk [on Tuesday], I think some short-covering around this arbitrage contributed to overall momentum,” Citi’s Nugent said. “We obviously saw a lot of spreads borrowing on the Comex, and that’s indicative of shorts being rolled forward.”

LME and Comex copper prices soared on Tuesday in particular, in contrast to steep declines in wider market indexes such as the S&P 500 and the Euronext 100.

Comex copper price contracts have risen far ahead of their LME counterparts this past week. 

Strong demand, but was it really that strong?
One indication of the roaring copper market in the US was the premiums paid for spot copper cathodes over exchange prices.

Higher or lower premiums reflect greater or smaller costs of shipment and financing, as well as supply and demand for material needed in the next month.

Fastmarkets’ copper grade 1 cathode premium, ddp Midwest US, was assessed on July 27 at 8.0-8.5 cents per lb, the highest value on records that go back to 2010.

“Unlike lower premiums due to soft market conditions in Europe, China and other parts of the world, US demand has been strong and [was] keeping the physical premium higher,” Xiao Fu, head of commodities strategy at Bank of China International (BOCI) Global Commodities, said.

The demand boost was not being seen by everyone, however, with several physical market participants voicing concern that the underlying market had not changed despite prices rising.

“The numbers, and the squeeze on Comex, point to a shortage of copper. But everything in our market is the same – cathode was the same, scrap was the same, #1 copper was the same,” one buyer said.

Macroeconomic data did skew positively, however. The IHS US Flash Manufacturing Purchase Managers Index (PMI) hit a record 62.6 during July, in an index where a value of more than 50.0 indicates market growth.

Sources: Fastmarkets, IHS.

Where will supply come from?
With the additional premium being paid, the US was expected to see imports boom with market participants delivering units against the CME contract.

“Any copper that can come here, will [come here],” a US-based trader said. “When China’s paying $40 per tonne over [the price on the] LME and CME warehouse is $300 over [the same price], it’s just a matter of time before we become oversupplied.”

Additional units from Chile were likely to provide the US with more cathode, but one place it was unlikely that the market would go to for copper was Europe, where 132,325 tonnes, or 63% of all LME on-warrant stocks, are held and available through the exchange’s clearing system.

The vast majority of that stockpile was produced in Russia, with arrivals into LME sheds in Rotterdam coming on a monthly basis.

But Russian copper was subject to a 1% duty on entering the US, Citi’s Nugent said. The Russian grade-A brands were also not deliverable against the Comex contract.

Copper production capacity in the US was slightly reduced. Grupo Mexico’s ASARCO smelter at Hayden, in the state of Arizona, is one of just three copper smelters in the US and it was not producing anywhere near capacity, according to several sources with knowledge of the situation.

Copper concentrates from the company’s nearby Mission and Ray mines have been recently tendered on the market, an indication that this material was not being used for smelting locally.

Peñoles’ Milpillas mine and 45,000 tonnes-per-year SX-EW cathode production plant, which is another key regional supplier, has been shut since July 2020.

Curve comes in
The arbitrage has been forced open in part due to the differing structures in the London and Chicago futures forward curves for copper.

The Comex market is currently in a steep backwardation, with the lack of prompt material forcing up the July, August and September months.

The LME, meanwhile, is in a fairly consistent contango, indicating that supply in the near-term is sufficient.

Since the start of this week, what was a strong arbitrage lasting well into next year has lessened, while market participants trading the two contracts have sold Comex and bought LME.

The spread between the Comex and LME futures contracts has come in since July 27. 

But the positions have not yet been closed, and with difficulties affecting shipping globally, it may be some time before the arbitrage window shuts.

“The CME and LME arb increased steadily in July,” BOCI’s Fu said, “and could continue to increase at a moderate pace, or maintain at current levels in the coming weeks due to the divergence between the US and ex-US.”