LORD COPPER: Creating the Al financing monster was easy; controlling it will be another thing

Aluminium producers are urging the LME to take action over warehouse queues and rising premiums, but the financing monster is partly their creation.

Aluminium producers are urging the LME to take action over warehouse queues and rising premiums, but the financing monster is partly their creation.

I don’t think it would be stretching reality to suggest that the aluminium market is not a particularly happy place at the moment. Prices are languishing, premiums are high, and stocks keep on rising, while demand is relatively soft.

I’ve previously set out my views on the current uncomfortable relationship between premium and price, and why the current balance is not good for business, so I’m not going to rehash that now.

But what do the major producers have to say? Well, two of them seem to be using this situation as an opportunity to take pot-shots at the London Metal Exchange.
The producers urge action
Rusal would like the LME to resolve the warehouse queue issue by rejigging load-out rates; and Alcoa’s ceo is urging the LME to begin publishing something akin to a commitment of traders report to reveal – and, presumably, then control – the impact of speculative money on the price.

Well, most people I speak to agree that the size of the metal stockpile (both on- and off-warrant) is a drag on prices.

I fully understand that the stockpiled metal is reflected in the current price, in the sense that it is hedged forward, but equally, it is reasonable to assume that as long as it is there and visible it will deter substantial price rises. That’s why I took issue some months ago with Rusal ceo Oleg Deripaska’s “$2,400 per tonne very soon” aluminium price prediction.

But at the same time as the underlying price of aluminium is held down, the premium goes up. That’s because the warehouses and/or their trader allies can lengthen the queue almost as they wish; and the longer the queue, the higher the premium will go.

And the longer the queue, the greater the warehouses’ guaranteed income from rents.

Certainly, as Alcoa has said, the consumer can go direct to a producer and buy; but they will still pay the higher premium, because that is effectively set by the free market – read, “warehouse trade”.

No one can seriously claim they have difficulty in obtaining metal, the issue is that it comes at a very high premium.

The warehouse delays are not principally caused by physical demand, they are caused deliberately as a part of the financing operation. And the premium is the bit of the price that is largely unhedgeable – the underlying price can be taken care of on the LME.

The problem with playing with the load-out rates is that it addresses the symptoms, not the disease. Yes, you could demand faster despatch from warehouses, but you would probably find that the speed of metal coming in rose as well, thus negating the change.

At best, increasing load-out rates would be a stop-gap measure, and with the global economic circumstances showing no real signs of a significant change, unlikely to be effective.

Exposing the speculators?
So what of the idea of the LME demanding reports about the commitment of traders, showing breakdowns of open interest and thus exposing those speculative investors with no interest in physical metal?

First, I think it’s fair to say, the LME does have a pretty robust system of large position monitoring, and it also has the ability to act if it sees abuse occurring.

Second, I’m not sure that the information such transparency produces is actually worth very much. Physical traders speculate, as do – sometimes – consumers and, horror of horrors, producers.

Some banks tell us these days that their LME trading is purely to support their new physical businesses. I’m afraid that the blurred area where physical and futures businesses meet is too confused to allow a simple distinction between (good) hedgers and (bad) speculators.

The market is what it is; it serves all sides of the business and is free to be used by anybody who complies with the rules. Trying to isolate why trades are entered into is a pretty futile exercise.

The real underlying problem of the aluminium market is that the finance trade offered a much nicer alternative to cutbacks when economies started to go wrong. Some cutbacks have now been and are being made, but the monster has already been created; and creating it is much easier than controlling it.

Anybody who has the nous to blag their way into the Vlissingen or Detroit warehouses could go and see the metal – and then they’d be able to see whose brand marks were on it, wouldn’t they?

Lord Copper 
editorial@metalbulletin.com

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